ASIAN DEVELOPMENT BANK RRP: FSM 35448

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON TWO

PROPOSED LOANS AND A TECHNICAL ASSISTANCE GRANT

TO THE

FEDERATED STATES OF MICRONESIA

FOR THE

OMNIBUS INFRASTRUCTURE DEVELOPMENT PROJECT

October 2004

CURRENCY EQUIVALENTS (as of 30 August 2004)

Currency Unit – United States dollar ($)

ABBREVIATIONS

ADB – Asian Development Bank ADF – Asian Development Fund BSS – basic social services CFA – Compact of Free Association CPUC – Chuuk Public Utilities Corporation DOI – Department of Interior DPWT – Department of Public Works and Transport DTCI – Department of Transport, Communications and Infrastructure EIA – environmental impact assessment EIRR – economic internal rate of return EMP – environmental management plan EOCC – economic opportunity cost of capital EPA – Environmental Protection Agency FIRR – financial internal rate of return FSM – Federated States of Micronesia GTWA – Gagil-Tomil Water Authority IA – implementing agency ICB – international competitive bidding IDP – infrastructure development plan IEE – initial environmental examination IMR – infant mortality rate IS – international shopping KUA – Kosrae Utilities Authority LCB – local competitive bidding LIBOR – London interbank offered rate MIS – management information system OCR – ordinary capital resources OIDP – Omnibus Infrastructure Development Project O&M – operation and maintenance OMIP – operations and maintenance improvement program OMM – operation, maintenance, and management PIA – project implementation assistance PMU – project management unit PPMS – project performance management system PPTA – project preparatory technical assistance PSD – private sector development PSP – private sector participation PSRP – public sector reform program PUC – Pohnpei Utilities Corporation PWD – Public Works Department SIEE – summary initial environmental examination SOE – statement of expenditure SRP – short resettlement plan

TA – technical assistance TOR – terms of reference UNDP – United Nations Development Programme US – United States of America USDOI – United States Department of Interior WHO – World Health Organization WWTP – wastewater treatment plant YSPSC – Yap State Public Service Corporation

WEIGHTS AND MEASURES ft – foot/feet gal – gallon gpm – gallons per minute in – inch MW – megawatt

NOTES

(i) The fiscal year (FY) of the Government ends on 30 September. (ii) In this report, "$" refers to US dollars.

This report was prepared by N. Convard, Pacific Department.

CONTENTS

Page

LOAN AND PROJECT SUMMARY i MAPS ix I. THE PROPOSAL 1 II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES 1 A. Performance Indicators and Analysis 1 B. Analysis of Key Problems and Opportunities 2 III. THE PROPOSED PROJECT 5 A. Objectives 5 B. Components and Outputs 5 C. Special Features 7 D. Cost Estimates 7 E. Financing Plan 8 F. Implementation Arrangements 9 IV. TECHNICAL ASSISTANCE 12 V. PROJECT BENEFITS, IMPACTS, AND RISKS 12 A. Policy Reform 13 B. Institutional Strengthening 14 C. Social Dimensions 14 D. Financial Aspects 15 E. Economic Aspects 17 F. Environmental Aspects 17 G. Project Risks 18 VI. ASSURANCES 18 A. Specific Assurances 18 B. Condition for Loan Effectiveness 20 C. Condition for Disbursement 20 VII. RECOMMENDATIONS 20 APPENDIXES 1. Sector/Subsector Analysis 21 2. External Assistance 26 3. Project Framework 27 4. Cost Estimates and Financing Plan 34 5. Implementation Schedule 36 6. Indicative Procurement Packages 37 7. Outline Terms of Reference for Project Implementation Assistance 38 8. Outline Terms of Reference for Chuuk Operations, and Maintenance Service 41 9. Outline Terms of Reference for the Technical Assistance 43 10. Short Resettlement and Land Acquisition Plan 45 11. Summary Poverty Reduction and Social Strategy 46 12. Summary Financial Analysis 48 13. Summary Economic Analysis 53 14. Findings and Conclusions of the Summary Initial Environment Examination 58

SUPPLEMENTARY APPENDIXES (available on request) A. Pohnpei PPTA Report B. Chuuk PPTA Report C. Kosrae PPTA Report D. Yap PPTA Report E. Summary Initial Environmental Examination F. Chuuk Operation, Maintenance and Management Services Contract: TOR G. PIA and TA Cost Estimates and Financing Plan

LOAN AND PROJECT SUMMARY

Borrower The Federated States of Micronesia (FSM)

Classification Poverty classification: Poverty Intervention (Following the Board approval of the R-Paper, Review of ADB's Poverty Reduction Strategy, staff instructions to replace the PI/CPI classification with a new tracking system are under preparation in line with paragraph 83 of the R-Paper.) Sectors: Multisector; Water supply, sanitation, and waste management; and Energy Themes: Environmental sustainability; Sustainable economic growth; Inclusive social development; and Governance Subthemes: Urban environmental improvements; Developing urban areas; Human development; and Public enterprise reform

Environment Category B (nonsensitive) Assessment Will have a positive effect on environment and public health

Project Description The Project includes (i) wastewater system improvements (Pohnpei), (ii) power rehabilitation (Chuuk), (iii) water supply system ugrading (Kosrae), (iv) water supply development and rehabilitation (Yap), (v) sanitation improvement program, and (vi) project implementation assistance. Outputs for each state are as follows:

Pohnpei: (i) installation of new sewers (various purposes – 9,700 feet [ft]); (ii) rehabilitation of the existing sewer network including lift stations; (iii) expansion of the sewerage system to Sokehs district (450 connections); (iv) design, construction and operation of a secondary wastewater treatment plant (WWTP), with a capacity of 1.2 million gallons per day, and constructed wetlands for tertiary treatment (about 2.5 acres); and (v) an inflow and infiltration study.

Chuuk: (i) design, construction, and operation of a replacement power generation station for Weno Island (7 megawatts), with modularized diesel engine generator units; (ii) power distribution upgrades, including 1,260 prepayment meters; (iii) decommissioning and environmental remediation of the existing power station; and (iv) institutional strengthening utilizing external private sector support for operation, maintenance, and management functions.

Kosrae: rehabilitation and upgrades to three water supply systems: Mutunte, Utwe, and Walung. System improvements for all include (i) rehabilitation of transmission pipelines; (ii) construction of treatment plants including sedimentation tank, slow sand filtration clearwater storage reservoir, and chlorination; (iii) provision of pumping facilities; and (iv) rehabilitation of the distribution network. A new intake and transmission line will be provided for Walung, while those of Utwe and Mutunte will be rehabilitated.

Yap: (i) provision of treated piped water supply to Maap and Maakiy comprising (a) connection to existing Gagil-Tomil system reservoir at ii

Doeweelil, (b) connection to an existing system for the villages of Palaaw, Qamin, Wachalaeb, Choqol, and Waalooy to Gagil-Tomil system, and provision of a new distribution system for the villages of Bechyal, Tooruw and Wanead and connecting these to the Gagil- Tomil system; (c) transmission pipelines and storage reservoirs; a storage reservoir located north of Qamin for emergency supply to Rumung (a separate island); and (d) service connections and meters for all households; (ii) rehabilitation of the existing Gagil-Tomil system; and (iii) installation of a 6 inch production well in Maap to provide water security.

Rationale Although the national and state governments of the FSM continue to improve infrastructure throughout the four states, infrastructure remains deficient in many respects. Recent developments such as the recent cholera outbreak in Pohnpei due to inadequate water and wastewater infrastructure, and the near-collapse of the electrical power system on Weno Island, the Chuuk state capital island emphasize the urgency of improvements. Infrastructure deficiencies have threatened human health and the environment, and impeded economic development. Future infrastructure investment needs for the next 20 years are estimated to exceed $1.4 billion, and although the FSM is receiving significant infrastructure funding under the Compact of Free Association (CFA) with the United States (US), this funding will only partially meet future investment needs. Additional funding is necessary.

Pohnpei: The existing wastewater treatment plant operates at or near full capacity, is at the end of its engineered lifespan, and is difficult to maintain. It is poorly located on elevated land, requiring significant lift pumping of effluent and preventing connection of certain low-lying areas to the system. Sewerage system leaks and overflows due to the entry of rainwater during heavy rains result in raw sewage flows into the environment, increasing the risk of human exposure to infectious diseases. The existing outfall discharges effluent into a narrow channel and degrades water quality. The area for sewerage expansion, Sokehs, suffers from poor environmental living conditions due to lack of adequate sanitation, exacerbated by rainfall and geologic conditions that do not allow proper functioning of individual systems.

Chuuk: The electrical power sector on Weno Island is in a state of crisis, and thus compromises the delivery of Government operations and essential services, impedes economic growth, and disrupts the lives of most of the island inhabitants. The power generation system is on the verge of collapse—only two primary engine generators are functional, though suffering frequent malfunction, and are seriously overdue for major overhaul. The power station is significantly damaging the surrounding environment and its operations pose significant health and safety risks. Power distribution system maintenance is hampered by the lack of access rights onto private property, and insufficient materials and equipment due to financial constraints. The power system is owned and operated by the Chuuk iii

Public Utilities Corporation (CPUC). Although CPUC has historically suffered from chronic institutional weakness, internal initiatives are being attempted to correct deficiencies and improve performance.

Kosrae: Although Kosrae has abundant surface water resources, none of the water being provided is currently treated. This seriously affects human health. In addition, tap water often displays brown discoloration and foul odor, which cause concern to the island inhabitants and negatively affects tourism.

Yap: Water supply systems of the municipalities of Maap and Rumung and the village of Maakiy are inadequate in quality (no treatment of surface water) and reliability of supply. Several villages are not served at all and have only rainwater catchments. The Gagil- Tomil system is in need of rehabilitation to sustain water quality and reduce water losses.

Objective The overall objective of the Project is to enhance public health and the environment through assistance to improve water supply infrastructure in Kosrae and Yap, and wastewater infrastructure in Pohnpei; and to support economic growth and poverty reduction in Chuuk through improvements to the electrical power sector. The project objectives include (i) improved public health through enhanced quality of and access to potable water in Kosrae and Yap; (ii) enhanced public health, environmental quality, and surface and groundwater quality through provision of wastewater management and infrastructure in Pohnpei; and (iii) poverty reduction, support for economic growth and environmental improvements through power generation and distribution improvements, and power station environmental remediation in Chuuk. The Project also advances private sector development by providing improved infrastructure and an enhanced business environment.

Cost Estimates The total project cost is estimated at $30.2 million equivalent, including foreign exchange of $24.1 million (about 80% of the total) and local currency of $6.2 million (about 20%). Cost estimates cover (i) land, (ii) physical works (civil works, equipment and materials), (iii) consulting services, (iv) contingencies, (v) financial charges, and (vi) taxes and duties estimated at $2.5 million. ($ million) Financing Plan Foreign Local Total Source Exchange Currency Cost Asian Development Bank (ADF) 14.2 14.2 Asian Development Bank (OCR) 4.8 4.8 Government 5.1 6.2 11.3 Total 24.1 6.2 30.2 ADF = Asian Development Fund, OCR = ordinary capital resources. Note: Figures may not add up to total because of rounding. Source: Asian Development Bank estimates. iv

Loan Amounts and The loans will be $14.2 million equivalent from the Asian Terms Development Bank (ADB) Asian Development Fund (ADF) and $4.8 million from ADB’s ordinary capital resources (OCR). The ADF loan will have a 32-year term, including a grace period of 8 years. The interest rate charged will be 1.0% during the grace period and 1.5% thereafter. The OCR loan will be provided under ADB’s London interbank offered rate (LIBOR)-based lending facility. The loan will have a 25-year term including a grace period of 5 years, an interest rate determined in accordance with ADB’s LIBOR-based lending facility, and a commitment charge of 0.75% per annum.

Allocation and The Government will relend a portion of the loan proceeds under the Relending Terms same terms and conditions agreed upon with ADB: (i) to CPUC for the Chuuk power component; (ii) to Pohnpei Utilities Corporation (PUC) for the Pohnpei wastewater component; and (iii) to the state governments of Kosrae and Yap, which will be responsible for the repayment of the loan proceeds for the Kosrae water supply component and the Yap water supply component, respectively.

Period of Utilization 30 January 2005 to 31 December 2009

Estimated Project 30 June 2009 Completion Date

Executing Agency Department of Transport, Communications and Infrastructure (DTCI)

Implementation A project steering committee has been constituted, chaired by the Arrangements secretary of DTCI. Other committee members are senior representatives of the Department of Finance and Administration, Department of Economic Affairs, representatives from the four state governments, and representatives of PUC, CPUC, Kosrae Utilities Authority (KUA), and Gagil-Tomil Water Authority (GTWA).

The Project will have six joint implementing agencies (IAs): PUC (Pohnpei), CPUC (Chuuk), Department of Finance and Planning (Division of Construction and Engineering), and KUA (Kosrae), and Department of Public Works and Transport (DPWT) and GTWA as joint IAs in Yap.

Procurement ADB-financed goods and services will be procured in accordance with ADB’s Guidelines for Procurement. Major contracts for civil works costing over $1 million and equipment purchases valued at $500,000 or more will be undertaken through ADB’s international competitive bidding procedures (ICB), and equipment packages valued at less than $500,000 will be procured following ADB’s procedures for international shopping. One exception to these procedures will be the procurement of electrical power engine generator units for Chuuk, which will be completed through international shopping because of a relatively limited number of manufacturers of this equipment. Civil works estimated to cost $1 million or less per package will be carried out under local competitive bidding (LCB) procedures acceptable to ADB, and in accordance with government procurement laws and v

regulations.

Consulting Services The loan will fund recruitment of a firm to provide 71 person-months of international and 93 person-months of domestic consulting services for project implementation assistance and related capacity building. Consulting services will be recruited in accordance with ADB’s Guidelines on the Use of Consultants, using the quality-based selection (QBS) method, and other arrangements satisfactory to ADB for engaging domestic consultants. Advance Action and Retroactive Financing ($2.8 million) will be provided for the urgent recruitment of consultants, for the procurement of electrical power engine generators and ancillary equipment for Chuuk to supplement power generation on Weno Island, and for meeting urgent power needs. The advance action allocation includes the provision of 1,260 prepayment electricity meters to be installed to facilitate improved tariff collections.

Project Benefits and Economic, socioeconomic, and environmental benefits associated Beneficiaries with the Project are high. Benefits will accrue from the strengthening of the public utility corporations in each state: improved cost recovery through a more commercial approach to management, and through the promotion of more autonomous, effective, and sustainable service delivery. Staff of the PUC, CPUC, KUA, and GTWA will upgrade their skills and capabilities through training. The Government will benefit from improved environmental and health outcomes, and reductions in health expenditure due to water-related diseases.

Pohnpei: The Project will improve environmental conditions, reduce health risks, and enhance amenities to the approximately 5,700 residents of Kolonia and 2,800 residents in low-income Sokehs, 3,600 working population, and several thousand visitors per annum to the Kolonia area. It will reduce the serious pollution of streams, drains and coastal waters; and mitigate unhealthy conditions in lower income areas. Improved and expanded sanitation services will directly benefit residents, commercial enterprises, and other consumers. Infrastructure improvements will result in more efficient and cost-effective operations. The Project will facilitate decommissioning of the existing wastewater treatment facility and reduce negative impacts of this facility on adjacent communities.

Chuuk: The Project will benefit about 2,290 government, residential and commercial consumers comprising nearly 15,000 people throughout Weno Island (over 60% of whom are poor); improve the lives of the people; and reduce their expenditure on energy. Rehabilitation of the power generation and distribution system will make power supply more reliable. Improvements to the power sector will facilitate improvements to water, wastewater, health, and other social services.

Kosrae: The Project is expected to directly benefit a population of about 3,700, equivalent to nearly 50% of the total population of Kosrae, through the facilities for improved and expanded potable quality piped water supply. The Project will also improve health vi

conditions by reducing waterborne diseases.

Yap: The Project will benefit three municipalities with a combined population of 2,500, by providing a potable-quality, piped water supply system that connects an existing well field with abundant supply to an adjacent area with only limited and contaminated surface water resources.

Overall, about 36% of the population benefiting from the proposed Project, or about 10,400 people, are classified as poor. About half of this number are in Chuuk, 29% in Pohnpei, 13% in Kosrae, and 8% in Yap. Pro-poor tariff reforms are included in the Project.

Risks and Project risks center on (i) meeting the CFA Infrastructure Assumptions Development Plan (IDP) requirements and availability of necessary CFA funds for counterpart financing, (ii) successful implementation of institutional reforms, and (iii) successful establishment of tariffs to recover costs. Close coordination has been maintained with the United States Department of Interior (USDOI) and other US agencies to ensure harmonization of approaches and institutional, financial management, and operational reforms. CPUC institutional reforms are necessary to successfully implement the Project in Chuuk State. Recognizing this, CPUC has been instrumental in formulating a rehabilitation strategy for the sector, and has begun necessary reforms such as appointing a chief executive officer, rationalizing staffing functions and levels, installing prepayment meters and improving billing and collection functions, emphasizing the strong commitment of CPUC to implement necessary reforms.

Institutional reforms are also required in Kosrae and Yap to progressively centralize the ownership, operation, and maintenance of water supply systems. Government and public utility commitment to implement these reforms in both states has been demonstrated through dialogue with the affected communities and local stakeholders throughout project development.

Although Government and community land will be utilized for most project components, private land acquisition is required for the Kosrae component. Various planning and legal approvals are necessary for land parcels associated with the Pohnpei wastewater treatment facility, and also for the Chuuk power station. Both Pohnpei and Chuuk have commissioned a committee to work toward securing the relevant approvals to allow development to proceed.

Water tariffs will need to be established in Kosrae to recover costs for the three proposed water supply subprojects. Initially, risk of public opposition to tariff establishment could result in inadequate cost recovery and a need for government subsidy. The state government has demonstrated a strong commitment and ability to develop tariffs to improve cost recovery, and is committed to implementing public awareness and other initiatives relating to tariff establishment. The vii

Project emphasizes building community and other stakeholder awareness and commitment to the Project, and encouraging government and public utility corporation responsiveness to community needs.

Technical Assistance Associated with the Project is a concurrent technical assistance (TA) for institutional strengthening of public utility corporations in Chuuk, Kosrae, and Yap. The TA's Executing Agency will be DTCI. The TA has two components: (i) part A will support training programs and provide asset management and management information systems for CPUC, and (ii) part B will educate the public and make water consumers aware of the need for water conservation and water charges in Kosrae and Yap. CPUC will be the IA for part A and KUA (Kosrae), and DPWT/GTWA (Yap) will be the IAs for part B.

The TA involves 7 person-months of international and 12 person- months of domestic consulting services. The consultants will be recruited as individuals in accordance with ADB’s Guidelines on the Use of Consultants. The total cost of the TA is estimated at $460,000, with $400,000 financed by ADB. Expertise areas needed for the TA include training, community awareness, and public relations.

THE PROPOSAL

1. I submit for your approval the following report and recommendation on proposed loans to the Federated States of Micronesia (FSM) for the Omnibus Infrastructure Development Project. The report also describes a proposed technical assistance (TA) grant for institutional strengthening, and if the Board approves the proposed loans, I, acting under the authority delegated to me by the Board, will approve the TA grant.

I. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Performance Indicators and Analysis

2. The FSM consists of 607 islands within approximately 2.5 million square kilometers (km2) of the northern Pacific Ocean. It comprises four states: Chuuk, Kosrae, Pohnpei, and Yap. The population is approximately 107,000:1 Chuuk, 54,000; Pohnpei, 34,000; Kosrae, 8,000; and Yap (11,000). Each state has its distinct cultural, socioeconomic, and political characteristics. The FSM became an independent nation in 1986, under a Compact of Free Association (CFA) with the United States of America (US). As part of the CFA, the FSM has received considerable funding that led to a substantial expansion of the economy and significant growth in public sector expenditure. But throughout the 1990s, scheduled declines of CFA resource transfers slowed and economic growth ultimately precipitated a major economic decline after 1997. From 1996 to 2000, the median individual average income declined significantly from $2,637 to $1,489 and corresponded to a sharp increase in the number of the poor (annual income below $1,000) from 6,426 to 15,083. Unemployment increased from 16% to 22%; primary education enrollments declined from 34,582 to 32,100. There was a sharp increase in emigration, and the population growth rate declined from 1.9% to 0.3%. Over the same period, life expectancy increased from 65 to 67 years, and infant mortality rate (IMR) went down from 46 to 40 per thousand. Due to the economic and social decline, the Government2 implemented sweeping structural adjustment policies and national reform programs, including a public sector reform program to rationalize the public sector and encourage private sector participation (PSP). By 2000, the Government payroll had been reduced by 30% in nominal terms and public servant staffing by 23%, and major program components promoting PSP had been established. The CFA has been renewed for 20 years. An infrastructure development plan (IDP) that recommends an infrastructure development program over the period of the CFA (2004–2023) was prepared. A total infrastructure investment of $748 million is envisaged, including $142 million for the water and wastewater sectors, and $81 million for electrical power. About $372 million is anticipated from CFA contributions and $359 million from other sources. The CFA requires stringent management controls. 3. During the early 1990s, each state created government-owned public utility corporations to more effectively provide, maintain, and improve water, wastewater, and electrical power systems.3 The performance of the utility corporations is widely variable. Proposed infrastructure investments are urgently needed (Appendix 1). Nationally, 50% of households do not have piped water, 44% lack toilets, 75% are not connected to sewerage or septic tank systems, and 45% do not have electrical power. These aggregate national indicators tend to disguise major differences between states; for example, only 24% of households in Chuuk have piped water, and only 18% have access to electricity; in Weno, where most of the population with access line, power outages are common. About 93% of the population of Yap proper4 have access to piped water; in some

1 Source: FSM National Census Report, 2000. 2 Government refers to the national Government; state governments will be specifically referred to. 3 Including (i) Pohnpei Utilities Corporation (Pohnpei State); (ii) Chuuk Public Utilities Corporation (Chuuk State); (iii) Kosrae Utilities Authority (Kosrae State); and (iv) Yap State Public Service Corporation (Yap State). 4 Yap proper refers to the main island of Yap and immediately adjacent islands, not including outer islands. 2 areas, however, the water is not treated.5 In Kosrae, about 98% of the population have piped water supply; however, the water is treated in only one small system.6 Kosrae has relatively good sanitation facilities, with about 91% of the population having access to toilets and 73% of these have septic tanks. In Pohnpei, the sewerage system serves the central urban area of Kolonia, or about 1,000 persons (20% of the total population). Pohnpei’s Sokehs area suffers from poor sanitary conditions as existing individual systems are not suitable for its high population density and rocky geologic conditions. This situation also constrains the use of decentralized systems in other parts of Kolonia. The system, which has served the Kolonia area for several decades, has become less efficient over time and raw effluent discharges are increasingly common. Service provision within states is also variable—urban centers receive higher service levels, while many rural areas rely on untreated water sources and lack sanitation and electricity. 4. Waterborne diseases are a major concern. Records from the late 1990s conservatively indicate 5,000 cases annually. Pohnpei suffered a cholera outbreak in 2000. While the data has anomalies, the trends indicate no significant improvements and possible worsening in the prevalence of key indicator diseases such as diarrhea and gastroenteritis. These data indicate that water supply and sanitation improvements are necessary to improve FSM’s health status and reduce outbreaks of serious water-related diseases. 5. Chuuk has suffered chronic outages throughout the past decade.7 During June to December 2003, Weno Island suffered generation outages for about 30 days, and a further 50 days of distribution system outages. Currently, outages occur almost daily.

B. Analysis of Key Problems and Opportunities

6. PUC, which owns and operates the water, wastewater, and electrical power systems in Pohnpei, is generally well-run. Water supply and electrical power services are relatively stable. The wastewater treatment plant (WWTP) operates at or near full capacity, is at the end of its engineered life span, and is difficult to maintain. It is poorly located in a residential area on elevated land and requires significant pumping of sewage. As a result, some low-lying areas are not connected to the system. The collection system has deteriorated, and sewage leaks. Because of overflows due to rainwater inflows, raw sewage flows onto the ground surface and into surface waters, increasing the risk of human exposure to infectious diseases. The existing outfall discharges to a narrow channel and causes unacceptable water quality degradation. 7. Infrastructure provision in Chuuk is seriously constrained by lack of electrical power. On Weno Island, the capital island, the power crisis compromises the delivery of government operations and essential services, impedes economic growth, and disrupts the lives of island inhabitants. The power generation system is on the verge of total collapse—only two primary generators are functional, and both frequently malfunction. The auxiliary equipment is highly deteriorated and insufficient to support operations. The power station seriously contaminates the site and perpetuates an unsafe and potentially dangerous environment. The operations pose significant health and safety risks. The power station is located on private land; lease payments are several years in arrears and disputes with landowners have seriously affected operations. Maintenance of the power distribution system is hampered by the lack of private property access rights, tree trimming rights, and materials and equipment. Power supply constraints deny the benefits of electricity to households and compel commercial and government consumers to resort

5 During the past 5 years, the Yap water supply system benefited significantly from the previous Asian Development Bank loan intervention, which expanded production capacity and increased the number of service connections in the urban area. 6 In 1992, a state-commissioned water sector master plan for Kosrae found high levels of contamination in surface water systems and high levels of unaccounted for water. These deficiencies are still evident. 7 Specific quantitative data on outages are unavailable. 3 to costly self-generation that is inefficient and is a substantial drain on productivity. For many years, the Chuuk Public Utilities Corporation (CPUC), which owns and operates the power, water, and wastewater utilities on Weno Island, has suffered chronic institutional weakness, poor service delivery and significant financial losses. The current CPUC Board, which has been in place for about 1 year has demonstrated much improved business acumen, but lack specific knowledge and experience with power utilities. 8. Although Kosrae has abundant surface water resources, none of the water in public systems is treated. Lack of treatment seriously affects human health. Piped water is often discolored and has a foul odor, which causes concern to the island residents and negatively affects tourism. Water charging has not been established; the results are operation and maintenance (O&M) funding deficiencies and high water use with much wastage. Municipalities own and operate the water supply systems, assisted by the Public Works Department, an arrangement that greatly increases the complexity and cost of service provision. The Kosrae Utilities Authority (KUA), which was established to provide water supply, and wastewater and electrical power services, does not operate any of the water systems. The Kosrae state government has committed to transferring operation and management of all water systems to KUA in a phased manner and expects to enact legislation mandating this and incremental water charging by the end of 2003. 9. Three water supply systems currently serve Yap proper, providing piped water to over 93% of the total population. The municipalities of Maap and Rumung, and the village of Maakiy are still supplied by untreated small-scale community and household catchments, and there is widespread stakeholder consensus that providing a safe and reliable water supply to these areas is a priority. The Yap State Public Service Corporation (YSPSC) provides water supply to central Yap proper, and the Gagil-Tomil Water Authority (GTWA) and Southern Yap Water Authority provide water in Gagil-Tomil and southern Yap proper, respectively. GTWA generally manages its system well. Still the system is beginning to deteriorate and suffers water losses estimated at 40– 50%. Water quality is generally good, but is beginning to show the effects of leaks and lack of chlorination. 10. Institutionally, PUC is relatively well developed; KUA is well-managed, but lacks specific capacity in water supply; GTWA functions adequately but needs support on technical issues and improved management systems to adequately manage the expanded system; CPUC is in need of comprehensive institutional reform, including external private sector assistance in operation, maintenance, and management functions. The Project includes a substantial long-term capacity- building component8 for CPUC, and training and establishment of long-term cooperation arrangements for Yap and Kosrae. The Project provides the opportunity to foster the Government's goals of improving the efficiency and autonomy of the public utilities it established a decade ago and lays the groundwork for future PSP. 11. The Asian Development Bank (ADB) has financed one infrastructure loan9 in the water supply and sanitation sector, covering Pohnpei, Chuuk, and Yap (Appendix 2). This project was closed in October 2002 and except for the Chuuk subcomponents,10 has been successfully

8 This is consistent with ADB. 2003. Special Evaluation Study: ADB Capacity Building for Managing Water Supply and Sanitation to Pacific Developing Member Countries. Manila, that recommended long-term capacity building activities. 9 ADB. 1996. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Federated States of Micronesia for the Water Supply and Sanitation Project. Manila. 10 Water supply improvements for Chuuk State included the installation of groundwater extraction wells, transmission pipes, water meters, and supporting infrastructure and equipment; and the rehabilitation of water storage tanks, and a water treatment plant. Many of the wells are not operational due to land access, water quality and power disruption issues; counterpart equipment was not supplied as originally intended, and there is an ongoing lack of replacement materials and equipment to ensure adequate operations. 4 implemented.11 In addition, ADB has financed two other projects and one program,12 all designed to aid in improving infrastructure and support public sector reforms. Through the CFA, the US has also provided extensive support to infrastructure. Lessons learned from the experience of ADB and other aid agencies in the FSM and similar Pacific countries include the following: (i) utility corporations need long-term capacity building and effective management systems to function effectively in project implementation and operations; (ii) detailed financial planning and management need to be implemented to ensure the long-term financial viability of infrastructure investments; (iii) infrastructure component design, and O&M must be appropriate for Pacific island conditions and constraints; (iv) land tenure is an integral part of project design and implementation and, given the difficulties of land acquisition particularly in Chuuk, land acquisition needs to be avoided or minimized; (v) early implementation of a community awareness program on issues such as water pricing and the health benefits of clean water will promote community support and willingness to pay for the service; (vi) sanitation improvements and community awareness of sanitation and hygiene should be integrated with water supply improvements to realize health benefits; (vii) water quality and water-related health statistics, and other baseline data management systems need to be improved to monitor project outcomes; and (viii) the use of local skills and training should be prioritized throughout project implementation to develop local capacity to operate and maintain infrastructure. 12. The Project addresses these lessons learned through a variety of targeted interventions. Capacity building will be provided to each of the public utility implementing entities of the four FSM states, in particular to CPUC in Chuuk through implementation of an operation, maintenance, and management (OMM) support services contract to build capacity over 5 years, supplemented by TA capacity building. KUA and GTWA also will be supported through TA capacity building for community awareness and public relations support. The project implementation assistance (PIA) consultancy also provides capacity building support. The project preparatory technical assistance (PPTA) completed a thorough financial evaluation of each implementing agency and identified tariff reform measures that allow for incremental progressive cost recovery to be achieved. Infrastructure components emphasize least-cost, low- maintenance solutions, appropriate for island environments. Land acquisition requirements have been kept to a minimum and, where land is required, priority is on the acquisition of government- and community-owned land parcels. Since land acquisition constraints in Chuuk are acute, mobile power generation system components are proposed to provide flexibility in their interim and longer-term location. Community awareness programs on water pricing and the health benefits of clean water have been included in PPTA activities and are included in the TA associated with this Project. A sanitation improvement program has been incorporated into the PIA to complement water system enhancements. The Project supports the development of local skills through training, capacity building, and local participation in civil works contracts. The need for improved water quality and health data has been part of the policy dialogue during loan processing and such data are emphasized in the project framework (Appendix 3). 13. The Project supports ADB’s strategy for the FSM13 by (i) fostering good water and environment governance, (ii) improving living conditions, and (iii) fostering pro-poor economic growth. Supporting water governance and the development of autonomous, sustainable water utilities reflects ADB’s water policy. It also supports the Government’s IDP and its economic development strategy and policies (3rd FSM Economic Strategy in March–April 2004).

11 ADB. 2004. Project Completion Report: FSM Water Supply and Sanitation Project (L1459-FSM). Manila (Draft). 12 ADB. 2000. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Federated States of Micronesia for the Basic Social Services Project. Manila; and ADB. 2001. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Federated States of Micronesia for the Private Sector Development Program. Manila. 13 ADB. 2002. Country Strategy and Program Update (2003–2005): Federated States of Micronesia. Manila. 5

II. THE PROPOSED PROJECT A. Objectives

14. The overall objective of the Project is to enhance public health and the environment, and to support economic growth and poverty reduction. Project objectives include (i) improved public health through enhanced quality and access to potable water for Kosrae and Yap; (ii) enhanced public health and environmental quality, and ambient water quality through provision of wastewater infrastructure for Pohnpei; and (iii) support for economic growth and environmental improvements through improvements in power generation and distribution and environmental remediation for the power station in Chuuk. The Project also advances private sector development by providing improved infrastructure and an enhanced business environment. B. Components and Outputs 15. The Project’s six components are (i) wastewater improvements (Pohnpei), (ii) electrical power rehabilitation (Chuuk), (iii) water supply improvements (Kosrae), (iv) water supply improvements (Yap), (v) a sanitation improvement program (nationwide), and (vi) project implementation assistance. Project outputs include (i) design, construction, and operation of a new WWTP and expanded sewerage system (Pohnpei); (ii) design, construction, and operation of a power generation station and improvements to the power distribution system (Chuuk); (iii) water supply system improvements and expansion (Kosrae and Yap); and (iv) strengthened institutions for utility management. 1. Component A: Wastewater Improvements, Pohnpei 16. Component A will improve the wastewater collection and treatment system for the Kolonia urban area by (i) installing a gravity sewer, an effluent transmission line, two force main sewers, and a sewage lift station to the new WWTP; (ii) rehabilitating the existing sewer collection network and modifying two lift stations; (iii) expanding the sewerage system to the Sokehs district with connections to 450 households using small bore sewers;14 (iv) designing, constructing, and operating a 1.2 million gal per day secondary treatment WWTP15 (v) designing, constructing, and operating tertiary treatment wetlands (approximately 2.5 acres); and (vi) conducting an inflow and infiltration study. CFA infrastructure financing will support closure and remediation of the existing Pohnpei solid waste dump site and develop an engineered landfill at a new location to allow construction of the WWTP at the old dump site. 2. Component B: Power Rehabilitation, Chuuk 17. Component B has three subcomponents: (i) Power generation. A replacement power station with a continuous power rating of about 7 megawatts (MW), comprising a series of modular diesel engine generator units with transformers, switchgear, lining, and cabling to directly connect to the existing 13.8-kilovolt distribution system. Auxiliary equipment includes storage tanks, protective building, storage container, foundation and hardstand areas, fire protection equipment, access gate, fencing, utilities, and drainage. (ii) Distribution system. Materials and equipment for power distribution system rehabilitation and regular O&M activities will be provided; these include a boom truck, flatbed truck, 1,260 cash power meters,16 other distribution system

14 Small bore sewers are smaller in diameter than conventional sewers and are possible because sumps with grinders are installed at each connection or group of connections. 15 The WWTP will be tendered as a design-build contract based on a concept design prepared by the project implementation assistance consultants. This may allow for alternative processes to be proposed that will achieve equal or better treatment and includes disinfection. Secondary treatment typically achieves effluent with biochemical oxygen demand less than 20 milligrams per liter (mg/l) and suspended solids content less than 20 mg/l. 16 Cash power meter is a prepayment meter system; 1,260 meters are sufficient to allow 100% of customers to switch to cash power meters. 6 components including conductors, transformers, insulators, braces, and poles. (iii) Power station environmental remediation. Remediation of the existing power station site includes (a) remediating contaminated soil and groundwater, as necessary; (b) removing, transporting, and disposing of hazardous building materials; (c) removing, transporting, and disposing of equipment, e.g., generators, oil circuit breakers, and transformers,17 which contain potential contaminants, and removing power plant buildings, infrastructure, and equipment to return the site to the landowners in an acceptable condition. (iv) CPUC management and technical operations strengthening. This includes OMM services for (a) personnel management and training; (b) financial management, and management information system (MIS); and (c) supervision of routine O&M over a 5-year period, with gradually declining inputs after the first 2 years. 3. Component C: Water Supply Improvements, Kosrae 18. Component C consists of infrastructure improvements and upgrades for the Mutunte, Utwe, and Walung water supply systems. It includes (i) rehabilitating intake structures for Mutunte and Utwe, (ii) repairing valves and other appurtenances as necessary on the existing transmission pipelines, (iii) constructing a new intake for Walung; and, (iv) for each system (a) constructing a sedimentation tank, slow sand filtration treatment plant, and clearwell reservoir; (b) providing chlorination facilities; (c) providing pumping facilities; and (d) rehabilitating the distribution network to provide adequate pressure throughout the system and limited distribution expansion.18 4. Component D: Water Supply Improvements, Yap 19. Component D will supply piped water to Maakiy and all villages in Maap and rehabilitate the existing Gagil-Tomil water supply system as follows: (i) Provision of piped water supply to Maap and Maakiy. This will involve providing (a) pipeline connecting the existing Gagil-Tomil system to a new storage reservoir at Doeweelil; (b) pipeline to connect to the existing systems supplying the villages of Palaaw, Qamin, Wachalaeb, Choqol, and Waalooy and to provide a new system for the villages of Bechyal, Tooruw, and Wanead; (c) pipeline to supply the villages of Maakiy and Talangith; (d) associated road and stream crossings for the pipelines; (e) new storage reservoirs at Doeweelil, the Waalooy/Choqol system, and north of Qamin for emergency supplies to Rumung; (f) service connections and meters for 161 households in Maap and Maakiy; and (g) a booster pumping facility with associated controls. Item (i) will involve disinfection and an allowance for rehabilitating the existing water supply systems to be included as part of the integrated system. (ii) Rehabilitation of the existing Gagil-Tomil system. This entails (a) replacing the well pumps and controls; (b) providing a chlorination system; (c) building a new 50,000 gal storage reservoir; (d) repairing the existing 100,000 gal reservoir; (e) replacing 5,000 ft of the existing transmission main; (f) providing maintenance equipment and materials; (g) replacing 9,500 ft of existing deteriorated pipelines; (h) upgrading office facilities and fencing the well field; and (i) extending service to two currently unserved villages. (iii) Installation of a well in Maap. This will provide water security and a reserve groundwater source.

17 PCB-containing transformers will be collected under an ongoing AusAID project in cooperation with the South Pacific Regional Environmental Programme, which is collecting persistent organic pollutants stored throughout the Pacific. 18 Financing will also be provided by the United States Department of Agriculture (USDA) for similar rehabilitation of the Malem water supply system, which will complete rehabilitation and improvement of all of Kosrae's major water systems. 7

5. Component E: Sanitation and Hygiene Training and Awareness Program 20. This component complements water supply improvements by providing support to address integrally related sanitation and hygiene issues. It includes government staff and community training on individual sanitation systems, and education and awareness programs.19 6. Component F: Project Implementation Assistance 21. Component F will provide PIA to the Executing Agency—the Department of Transport, Communications, and Infrastructure (DTCI)—and relevant agencies20 to undertake detailed designs, tender processing, and project management; and to provide assistance, advice, and training on all Project activities. C. Special Features 22. In Chuuk, the use of modular power generation units allows for rapid installation of generators to address the urgent power crisis and serve long-term power needs. Also, the provision for an OMM services contract to CPUC allows for sustainable capacity building and PSP in the power sector. The sanitation improvement program recognizes the linkages between sanitation and water supply to significantly reduce water-related diseases. In Yap, the Project supports key ADB water sector reform objectives by supporting and strengthening GTWA, a community-based autonomous water utility. In Pohnpei, sewerage system expansion uses innovative small-bore sewer technology. D. Cost Estimates 23. The project cost is estimated at $30.2 million equivalent, comprising foreign exchange of $24.1 million equivalent (about 80% of the total) and local currency of $6.2 million equivalent (about 20%). Cost estimates include (i) land, (ii) physical works (civil works, equipment and materials), (iii) consulting services, (iv) contingencies, (v) financial charges, and (vi) taxes and duties estimated at about $2.5 million. Table 1 shows the cost estimates; details are in Appendix 4.

19 Training materials will be made available for nationwide implementation. 20 For example, the Department of Planning and Statistics in Chuuk, the Department of Public Works in Kosrae, DPWT in Yap, PUC, CPUC, GTWA, and KUA. 8

Table 1: Cost Estimates ($ million) Foreign Local Item Total Exchange Currency A. Pohnpei Sewerage Collection and Wastewater Treatment 1. Technical Component 6.3 1.6 7.9 2. Engineering Design and Supervision 0.5 0.2 0.7 3. Physical Contingency 0.4 0.1 0.5 4. Price Contingency 0.1 0.1 0.1 5. Taxes and Duties 1.0 1.0 Total Pohnpei Subproject 7.2 3.0 10.2 B. Kosrae Water Supply 1. Technical Component 2.4 0.6 3.0 2. Engineering Design and Supervision 0.2 0.1 0.2 3. Physical Contingency 0.2 0.1 0.3 4. Price Contingency 0.0 0.0 0.0 5. Taxes and Duties 0.4 0.4 Total Kosrae Subproject 2.7 1.2 4.0 C. Yap Water Supply 1. Technical Component 2.2 0.5 2.7 2. Engineering Design and Supervision 0.2 0.1 0.3 3. Physical Contingency 0.2 0.1 0.3 4. Price Contingency 0.0 0.0 0.0 5. Taxes and Duties 0.4 0.4 Total Yap Subproject 2.6 1.0 3.6 D. Chuuk Power Supply 1. Technical Component 6.9 0.0 6.9 2. Engineering Design and Supervision 0.4 0.1 0.5 3. Management Services (5 years, from CPUC revenues) 1.8 1.8 4. Environmental Remediation 0.7 0.7 5. Physical Contingency 0.6 0.0 0.6 6. Price Contingency 0.1 0.0 0.1 7. Taxes and Duties 0.7 0.7 Total Chuuk Subproject 10.3 0.9 11.3 Finance Charges (IDC) 1.1 1.1 Total Including Contingencies 24.1 6.2 30.2 CPUC = Chuuk Public Utilities Corporation, IDC = interest and other charges during implementation. Note: Numbers may not add up to total because of rounding. Source: Asian Development Bank estimates. E. Financing Plan 24. The Government has requested a loan of $14.2 million equivalent from ADB’s Asian Development Fund (ADF) and a loan of $4.8 million from ADB’s ordinary capital resources (OCR). The ADF loan will have a 32-year term, including a grace period of 8 years. The interest rate charged will be 1.0% during the grace period and 1.5% thereafter. The OCR loan will be provided under ADB’s London interbank offered rate (LIBOR)-based lending facility. The OCR loan will have a 25-year term including a grace period of 5 years, an interest rate determined in accordance with ADB’s LIBOR-based lending facility, and a commitment charge of 0.75% per annum. The two loans will have such other terms and conditions as are set forth in the draft Loan Agreements. The Government will relend the loan proceeds under the same terms and conditions agreed upon with ADB. The relending amounts will be as follows: PUC–$5.5 million (ADF) and $2.0 million (OCR); CPUC–$2.6 million (ADF) and $2.8 million (OCR); Kosrae State–$3.2 million (ADF); and Yap State–$2.9 million (ADF). Kosrae and Yap will pass on their allocated amounts to their respective public utility corporations as capital infusion.

9

25. The FSM is a category B-1 country eligible for 75% financing of the ADF portion of the estimated project cost. OCR funding is required since the project cost exceeds the currently available national allocation of $14.2 million ADF funds. Government counterpart funding will provide $11.3 million equivalent. Government funding will be sourced from CFA infrastructure- designated funds for the respective states. The Government is committed to providing timely counterpart funds and will incorporate the required amounts into the budget for financial years 2004–2005 onward. Counterpart funding requirements and debt service on the loans are reasonable compared with Treasury resources and ongoing commitments. Table 2 shows the summary financing plan. Table 2: Financing Plan ($ million) Foreign Local Total Sources Exchange Currency Cost Percentage Asian Development Bank ADF 14.2 14.2 47.0 OCR 4.8 4.8 15.7 Subtotal 19.0 19.0 62.7 Government Utility Internal Fundsa 1.8 1.8 5.9 Land 0.6 0.6 1.8 Government Cash Contribution 3.3 5.6 8.9 29.6 Subtotal 5.1 6.2 11.3 37.3 Total 24.1 6.2 30.2 100.0 ADF = Asian Development Fund, OCR = ordinary capital resources. Note: Figures may not add up to total because of rounding. a Chuuk Public Utilities Corporation (CPUC) financing of the operation, maintenance, and management service contract. Source: Asian Development Bank estimates. F. Implementation Arrangements 1. Project Management 26. DTCI will be the Executing Agency. The PPTA steering committee will remain as the project steering committee with the addition of the involved utilities. The committee will continue to be chaired by the DTCI secretary and include senior representatives of the Department of Finance and Administration, Department of Economic Affairs, and representatives from the governments of Pohnpei, Chuuk, Kosrae, and Yap, and representatives of PUC, CPUC, KUA, and GTWA. The Project will have six implementing agencies (IAs): PUC (Pohnpei), CPUC (Chuuk), Department of Finance and Planning (Division of Construction and Engineering), and KUA (Kosrae), and Department of Public Works and Transport (DPWT) and GTWA as joint IAs in Yap. A project management unit (PMU), which will be part of the PMU for the CFA-funded infrastructure development program, will be established within DTCI. The PMU will be assisted by coordinators from each of the IAs, and PIA. During project preparation, the financial management capacity of DTCI and the six IAs was evaluated. The financial management capacities of DTCI, KUA, GTWA, and PUC were found to be satisfactory, and will be supported by the implementation consultants. CPUC will receive direct support in financial management from the implementation consultants and from the OMM contract. 2. Implementation Period 27. The loan will be effective by the beginning of the first quarter of 2005 (Appendix 5). Preparatory activities, including detailed design, tender documentation, and procurement of consulting services, will be completed by the end of 2005, with construction and commissioning of 10

Chuuk, Kosrae, and Yap systems to be completed by mid–2008. Through advance action, three of the modular power generators for Chuuk will be installed by end–December 2004. Due to counterpart funding requirements and the need to complete closure of the existing solid waste dump, construction of the Pohnpei component will begin in 2007. This time frame takes account of the wet season and appropriate construction periods. 3. Procurement 28. ADB-financed goods and services will be procured in accordance with ADB’s Guidelines for Procurement. Major contracts for civil works valued at greater than $1 million and supply contracts valued at $500,000 or more will be undertaken through ADB’s international competitive bidding (ICB) procedures except that bidding periods will be reduced to 45 days since the works are not complex and contractors can easily prepare the bids in the shortened period. Equipment packages valued at less than $500,000 will be procured following ADB’s procedures for international shopping (IS). An exception to these procedures will be the modular generator units (component B [i]), which will be procured in accordance with ADB’s procedures for IS due to the limited number of suppliers of this equipment. Civil works estimated to cost $1 million or less per package will be carried out under local competitive bidding (LCB) procedures acceptable to ADB. Local contractors have the expertise and capacity to undertake such works, but are limited in number. In accordance with ADB requirements, foreign contractors may participate in the bidding for LCB contracts. Prequalification, selection, and engagement of contractors will be subject to ADB's approval.21 Upon completion of bid evaluation, the proposal for award of contracts will be submitted to ADB for approval. ADB will be furnished with three copies of (i) an account of the public opening of bids, (ii) summary evaluation of bids, (iii) the proposal for award, and (iv) a draft contract or letter of acceptance. Promptly after such award, ADB will be furnished with three copies of the contract as executed. The internationally tendered equipment packages will include technical support to ensure proper installation, testing, commissioning, and training of operational staff. Indicative procurement packages are in Appendix 6. 29. DTCI has requested ADB to approve advance procurement and retroactive financing of power generation equipment for Chuuk up to the amount of $2.8 million22 to mitigate the chronic power supply deficiencies. The equipment includes up to four modular generator units and associated transformers, switchgear, lining, and cabling. Advance action and retroactive financing includes the provision of 1,260 prepayment electricity meters to facilitate improved tariff collection. Advance action is also requested to initiate the early start of PIA consultant recruitment so that project implementation can proceed on time and project objectives can be achieved as soon as possible.23 Advance recruitment of consultants will follow ADB’s Guidelines on the Use of Consultants. The Government was advised that approval of advance action does not commit ADB to finance procurement and recruitment costs or to finance the Project. 4. Consulting Services 30. The Project includes three packages of consulting services: (i) project implementation assistance (PIA) (Appendix 7), and (ii) Pohnpei sewer system I/I study, and (iii) CPUC OMM Service Contract (terms of reference [TOR] in Appendix 8). Provision has been made for 71 person-months of international and 93 person-months of domestic consulting services to support PUC, CPUC, KUA, and DPWT/GTWA in project implementation. The following experts will be recruited: team leader-senior environmental engineer, water supply engineer, wastewater

21 ADB will encourage DTCI to use ADB-approved standard bidding documents to ensure high quality and consistency of the documents, which will hasten ADB’s review. 22 The advance action amount of $2.8 million represents approximately 15% of the loan amount, for exceptional circumstances in ADB Operations Manual, OM Section H4/BP. 23 Advance procurement requires that Chuuk repay an additional $250,000; appropriate payment of the remainder of the arrears for payment is in the first quarter of FY2005. 11 process engineer, power engineer, electrical or mechanical engineer, structural engineer, hydrogeologist, institutional specialist, financial management specialist, environmental specialist, construction management specialist, CADD specialist, sanitation-community development specialist, and public relations and awareness specialist. The consultants will provide assistance in the areas of ADB procedures and reporting, detailed design for water supply systems for Kosrae and Yap, concept designs for wastewater infrastructure and recruitment of design-build services in Pohnpei and power infrastructure in Chuuk, design review, procurement, quality control, construction supervision, start-up testing, commissioning, training in O&M, and implementation of the project performance management system (PPMS). Detailed design of the wastewater system for Pohnpei and the power generation system for Chuuk will be undertaken through design-build contracts. The PIA consultancy will provide the experts to implement the sanitation improvement program. Appendix 7 includes the TOR for the PIA consulting services. The detailed TOR for the I/I study consultants will be developed by the PIA consultants and separately contracted. The OMM service contract will be financed through counterpart funds provided by CPUC, which have agreed to follow ADB's consultant recruitment procedures. Consultants will be recruited as a firm for all packages in accordance with ADB’s Guidelines on the Use of Consultants, using the Quality-Based Selection QBS method and other arrangements satisfactory to ADB for engaging domestic consultants. The firms will be required to submit a full technical proposal. QBS is required to provide the necessary flexibility and innovation, as the project is complex and involves multiple sectors in multiple states. 5. Disbursement Arrangements 31. Immediately after loan effectiveness, DTCI will establish an imprest account for each loan (OCR and ADF). Replenishment to the imprest accounts will be supported by an appropriate withdrawal application and related documentation. The initial amount to be deposited in the imprest accounts will not exceed $300,000 equivalent. The statement of expenditures (SOE) procedure may be used to reimburse eligible expenditures and liquidate imprest account expenses. The SOE procedure is applicable to individual payments not exceeding the equivalent of $50,000. Detailed arrangements for establishing and operating the imprest account and SOE procedure will be made in accordance with ADB’s Loan Disbursement Handbook (2001). 6. Accounting, Auditing, and Reporting 32. DTCI and the IAs will maintain separate accounts for the Project. DTCI, through the PMU, and the IAs will maintain records of all project expenditures. DTCI, through the PMU, will prepare consolidated project accounts, which will be audited annually by independent auditors acceptable to ADB. Certified copies of such audited accounts will be submitted to ADB not later than 6 months after the end of the financial year to which they relate. An externally audited financial statement of government and IA project accounts will also be submitted to ADB annually, no later than 9 months after the end of the relevant financial year, for the entire implementation period. DTCI and the IAs were informed of ADB's policy on submission of audited financial statements and possible penalties for delays in submission. The submitted audited project accounts and financial statements must be of acceptable quality; financial statements with adverse opinions or disclaimers of opinion from auditors are not acceptable and cannot be submitted for this purpose. Independent review and scrutiny of project implementation will be undertaken for (i) environmental monitoring and adherence to the summary initial environment examination (IEE) and the Government’s environmental impact assessment (EIA) provisions, and (ii) audit of project accounts and compliance with loan covenants. The Government will submit to ADB reports and information concerning the use of the loan proceeds, project implementation, and IA performance. The reports will include (i) quarterly progress reports on project implementation; (ii) annual reports; and (iii) a project completion report, no later than 3 months after completion of the project facilities. 12

7. Project Performance Management System 33. The PPMS indicators agreed on during project preparation for components A, C, D and E include service levels; treated water and wastewater quality and other measures of operational performance; amount of water treated and wastewater collected and treated; user satisfaction with the urban environment; and relevant health, environmental, and economic data to monitor project impacts. For component B, the agreed-on indicators include service levels, power generation and distribution reliability, and relevant economic data to monitor project impacts. The relevance and practicability of data collection for the proposed measures have been confirmed with the Government. At the beginning of the Project, the PMU and IAs will develop comprehensive PPMS procedures to systematically generate data on inputs and outputs of project components and the agreed-on socioeconomic and environmental indicators to be used to measure project impacts. The PMU and IAs will refine the PPMS framework, confirm achievable goals, refine monitoring and recording arrangements, and establish systems and procedures no later than 6 months after loan effectiveness. Under the PPMS framework, baseline and progress data will be reported at the requisite time intervals by DTCI, which will be responsible for analyzing and consolidating the data through its management information system. The PPMS will permit adequate flexibility to adopt remedial action for project design, schedules, activities, and development impacts. The PMU will monitor and assess activities, and report to ADB quarterly on physical implementation, and financial and environmental aspects of the Project to ensure that progress and impacts are monitored and reported. 8. Project Review 34. Regular ADB review missions, and a midterm review by ADB and the Government will be undertaken about 2 years after project implementation begins. The review will evaluate in detail the scope, implementation arrangements, achievement of scheduled targets, and capacity building progress. Feedback from the PPMS will be analyzed.

III. TECHNICAL ASSISTANCE

35. A concurrent TA for institutional strengthening will be provided. The TA has two components: (i) part A for the support of training programs and provision of asset management and management information system (MIS) for CPUC, and (ii) part B for public education and awareness of water consumers of the need for water conservation and water charging in Kosrae and Yap. DTCI will be the executing agency. CPUC will be the IA for part A and KUA (Kosrae) and DPWT-GTWA (Yap) will be the IAs for part B. The TA involves 7 person-months of international and 12 person-months of domestic consulting services. The consultants will be recruited as individuals in accordance with ADB’s Guidelines on the Use of Consultants. The total cost of the TA is estimated at $460,000, of which $400,000 is in foreign currency and $60,000 equivalent in local currency. ADB will finance the total foreign currency cost on a grant basis to be financed by ADB's TA funding program, and the Government will finance the local currency component. Areas of expertise to be recruited under the TA include training, community awareness, and public relations. Appendix 9 gives the outline TOR.

IV. PROJECT BENEFITS, IMPACTS, AND RISKS

36. Improved and expanded sanitation services for Pohnpei will directly benefit residents, commercial enterprises, and other consumers of Kolonia town. The Project will improve environmental conditions, reduce health risks, and enhance amenities to about 5,700 residents, 3,600 working population, and several thousand visitors coming annually to Kolonia. About 450 households (2,800 people) in low-income Sokehs will be connected to the sewerage system, based on an innovative, low-cost collection system design. The system will reduce the serious pollution of streams, drains, and coastal waters; and remedy the unhealthy conditions in lower 13 income areas. Infrastructure improvements will result in more efficient and cost-effective operations. Indirect beneficiaries of the Project include the fisheries industry—improved marine resources due to reduction in seawater pollution—and the tourism industry—improved urban and marine environments. In Kosrae, a combined population of about 3,700 in two municipalities and three villages, equivalent to nearly 50% of the total population of Kosrae, will benefit directly through replacement of existing heavily contaminated surface water systems with facilities for supplying treated and reliable potable piped water. In Yap, the Project will benefit three municipalities (combined population of approximately 2,500) through the potable piped water supply system to an area with only limited and contaminated surface water resources. With reduced water-related diseases, public health will improve in Kosrae and Yap. Indirect beneficiaries will include the tourism industry through improved potable water quality and supply. In Yap, the Project will assist service delivery in an economically depressed area and support its economic development. In Chuuk, rehabilitation of the power system will make power supply more reliable and thus improve service to all consumers, including about 2,290 government, residential, and commercial consumers throughout Weno Island. The rehabilitated system will improve people's lives and reduce expenditure on energy. New facilities will reduce system losses, improve efficiency, and enhance operational performance. Since improved power delivery positively affects all of the commercial enterprises of the island, indirect benefits will accrue to most sectors. Rehabilitation of the power system also will yield significant benefits in health, water supply, and other social services dependent on electricity. 37. Benefits will accrue from the strengthening of the public utility corporations in each state. Adopting a more commercial approach to management, and promoting more autonomous, effective, and sustainable service delivery will improve cost recovery. Staff of PUC, CPUC, KUA, and GTWA will upgrade their skills and capabilities through training. The Government will benefit from improved environmental and health outcomes, reduced need for direct support for operations, and reductions in health expenditures. A. Policy Reform 38. The Project supports government water, wastewater, and power policy reforms and ADB's water policy initiatives, such as (i) improved utility management and planning, (ii) poverty reduction and access to basic services, (iii) cost recovery and tariff reform (para. 47), (iv) mainstreaming environmental management, and (v) stimulating private sector development and economic integration through improved services infrastructure. In Kosrae, the subproject will provide for efficient operations and sustained maintenance of all systems by centralizing them under KUA. All water users will be metered and billed for their consumption of treated water. Tariffs for all consumers will be introduced in gradual increments to give users time to adjust to the metering and billing process, and to the need to pay for water. KUA will be given assistance and training in water system O&M to allow a smooth transfer of the sector to the utility. 39. In Yap, all residents of the municipalities of Tomil, Gagil, Maakiy, and Maap will be served by a professional managed utility and pay rates that recover the O&M costs. Gradual tariff increases will be introduced to recover a rising portion of the capital costs of the new and refurbished supply infrastructure. In Chuuk, the Project will assist CPUC with substantial institutional strengthening, including billing reforms (prepaid system) and access to private land for system maintenance. In Pohnpei, PUC will clearly separate the water, sewer, and power cost centers to make any cross subsidies between them transparent. Policy dialogue with management to restructure tariffs to recover a greater portion of sewerage costs directly from users as the sewerage connections increase will continue. 14

B. Institutional Strengthening 40. In Chuuk, CPUC management and technical operations will be strengthened through the OMM services contract. Consultants will report to the CPUC chief executive officer and Board.24 The TA will also provide additional advisory support for CPUC Board policy and procedure development, Board member training, staff training, and provision of management information and asset management systems software and equipment. 41. The PIA consultancy and the associated TA will assist in the institutional strengthening of the involved utilities, namely, PUC, CPUC, KUA, and GTWA. Capacity building will be achieved via a program of formal, informal, and on-the-job training. In Kosrae, the PIA will provide assistance to support KUA in assuming responsibility for the water sector, including technical training, necessary organizational changes, and integrating water billing and revenue collection into current procedures. In Yap, GTWA will recruit additional expertise in technical operations and financial management. A new member from the Maap area will be recruited to the Board. The PIA consultancy will provide training in utility operations and administration to enable the utility to assume effective control over the larger system. C. Social Dimensions 1. Land and Resettlement 42. The overall government strategy for infrastructure development is to avoid land acquisition wherever possible, and the Project adopts this approach. Land acquisition is limited and no persons will require resettlement. About 15 landowners in Kosrae are affected. Community land in Yap and Government land in Chuuk and Pohnpei will be used for project facilities. Through lease arrangements, several small businesses operate out of shipping containers on the periphery of the Chuuk site. It is expected that these businesses can be accommodated on immediately adjacent Government-owned land. The Mission has reviewed the land acquisition procedures of the Government and state governments and is satisfied that these procedures are consistent with and provide the necessary protections of ADB’s Policy on Involuntary Resettlement. The level of resettlement is considered insignificant by ADB’s policy and only a short resettlement plan is required (Appendix 10). If any other land acquisition or resettlement becomes necessary in the course of the Project, the Government will notify ADB. In all cases, the Government will ensure that land acquisition is carried out in accordance with all applicable laws and regulations of the Borrower and ADB’s Policy on Involuntary Resettlement. 2. Poverty 43. The Project is classified as poverty intervention. The project will benefit both the poor and non-poor through the direct benefits of improved living conditions and public health, and indirect benefits of reduced income poverty arising from reduced health care costs, increased productivity, and economic development through growth in tourism. Of households in the project areas, about 12% in Yap,25 18% in Pohnpei and Kosrae, and 54% in Chuuk are estimated to be living below the poverty line.26 Overall, about 36% of the project beneficiaries, or about 10,400 people, are poor, with about 50% of this number in Chuuk and another 30% in Pohnpei (Appendix 11). System improvements in Pohnpei specifically target one of the poorer areas in terms of income and living conditions. In Chuuk, living conditions on Weno Island are poor, and the Project

24 The multiyear training will be financed by CPUC through cost savings resulting from installation of cash power meters and other reforms. 25 The estimate was made prior to the typhoon that devastated the island in early April 2004. 26 Percentages are based on data from the 2000 census. The FSM national poverty line is $867/person/yr or $5,982/household. See ADB. 2001. Poverty: Is it an Issue in the Pacific? Manila (Prepared under ADB. 2000 Poverty Assessment in the PDMCs. Manila [RETA 5907]). 15 has improvements for the entire island. In all states, tariff reform has been structured to ensure affordability of these basic urban services to the poor. A recent participatory poverty assessment identifies lack of access to basic services, including water supply, sanitation, and electricity, as a key component of poverty in the FSM.27 Income data in the FSM are not a reliable poverty indicator because of family support systems and subsistence living available to those with access to land. A family with little income but with several able-bodied workers and sufficient land and access to fishing may be able to provide the household sustenance although such families do not have adequate access to basic urban services. Thus, access to basic urban services is a better indicator of poverty and is a major benefit to the poor in terms of quality of life. 44. The Project will make a major contribution to improved public health, particularly to the poor who are the least likely to have safe and adequate water storage tanks. By providing safe water supplies in Kosrae and Yap, the Project will reduce the high incidence of water-related diseases, and risk of cholera outbreaks, which occurred in Pohnpei in 2000. Upgrading wastewater treatment infrastructure in Pohnpei will improve environmental quality and public health, particularly in the most densely-populated urban area. In Chuuk, providing reliable power supply to Weno Island will reduce waterborne diseases by giving households access to electrically pumped, treated well water. It will contribute to public health for all people in Chuuk by improving medical services that are currently undermined by power failures. 45. The Project will also boost tourism and associated private sector growth in all states by removing the adverse effects on tourism posed by inadequate water supplies and, in the case of Chuuk, by inadequate and unreliable power supply. Growth in tourism will improve employment opportunities in the private sector, and opportunities for business development and employment will increase. A further benefit to the poor will occur in Yap, where the Project will provide piped water to rural areas and enable many low-income people who are currently renting land in informal urban settlements to return to live on their own land. 46. Water and power are charged at rates affordable to the poor. Surveys conducted during the PPTA suggest that many Kosrae consumers are unwilling to pay for water, but this unwillingness may be related to low levels of public understanding of the health risk of their current water supplies. As service and awareness improve, it is likely that public attitudes will quickly change. D. Financial Aspects 47. Financial projections have been prepared for the four investment components in accordance with the Guidelines for the Financial Governance and Management of Investment Projects Financed by the Asian Development Bank to assess the financial viability and sustainability of each investment (Appendix 12 and supplementary appendixes A-D). The projected financial statements indicate that for the Yap, Kosrae, and Pohnpei components, current tariff levels are likely to generate revenues to cover O&M and management costs over the first 5 years of operation, but will not cover depreciation, debt service, or a rate of return to Government equity. The cash flow position has been evaluated and appropriate covenants included to ensure that resources to cover projected shortfalls are made available through appropriate budget allocations. Ongoing policy dialogue with respect to tariff policy and cost recovery mechanisms will continue throughout project implementation (particularly for PUC where specific assurances have been agreed upon to undertake a comprehensive tariff study). Given the social and economic benefits associated with these components, and appropriate covenants to ensure that sufficient funds will be available pending introduction of a cost recovery tariff structure, the component investments are considered sustainable. With respect to the Chuuk

27 ADB. 2002. National Poverty Reduction Strategies in Pacific Developing Member Countries. Manila (Participating Poverty Assessment, Draft Final Report [March 2004]). 16 component, financial projections indicate that current tariff levels will provide full cost recovery, including debt service and a reasonable return on investment. The projected financial performance of CPUC is strong and appears sufficient to cover OMM contract costs. 48. The financial evaluation of all four investment components was undertaken in real terms using constant 2004 prices. Given that the tariff structures for the Yap, Kosrae, and Pohnpei components are not sufficient for full cost recovery, the financial internal rate of return (FIRR) for these components is negative. The FIRR for the Chuuk component, computed on an after-tax basis, is 14.0%. This compares favorably with the after-tax weighted average cost of capital of 2.0%. The component is considered both financially viable and sustainable. Sensitivity and risk analysis indicates that the FIRR is robust under adverse conditions. A more detailed financial evaluation is in Appendix 12 and the supplementary appendix for Chuuk. 49. In Yap, metering and user charges at the tariff current in Gagil-Tomil will be introduced to the residents of Maakiy and Maap following integration with Gagil-Tomil. The current tariff is sufficient to recover OMM costs of the integrated system, but does not recover capital costs. A schedule of gradual increments to the tariff will be introduced to recover a target of 30% of annual capital depreciation. The FIRR of the Yap subproject is negative. The state will fund the capital and financing costs of the Project, with a portion of the capital costs reimbursed by GTWA as the capital recovery target is achieved. 50. In Kosrae, metering will be installed on all consumers and a tariff introduced in gradual increments to recover OMM costs over the first 5 years of the Project. Due to the long experience of Kosrae users with essentially "free" water and low willingness to pay for water, and the abundance of surface water for most residents, the scope to recover full costs including capital and finance costs is limited. The FIRR of the subproject is negative. The state government will fund the capital and financing costs of the Project. 51. In Pohnpei, the current charging mechanism is an implicit water volume-based sewerage surcharge for all water customers, whether or not they are connected to the sewerage system. Although this is sufficient to recover the OMM costs of the combined water supply and sewerage systems, the Project will generate no additional revenues. Arrears in the water account of any customer are applied to the customer’s prepaid electricity account and paid off gradually as electricity is purchased. The FIRR for the Pohnpei subproject is negative under these circumstances. However, the PIA consultancy will clarify the explicit financial performance of each of PUC’s cost centers (power, water, and sewer) to determine the degree of cross subsidization between them, and conduct dialogue with PUC to (i) make the cross subsidy transparent to the government, PUC, and consumers; and (ii) to adjust the tariff structure to provide for improved targeting of sewerage costs on users and reduced cross subsidy. 52. In Chuuk, the current tariff is sufficient to recover full costs and will be periodically reviewed. Through assistance to management and the Board under the OMM services contract, revenue collection will be substantially increased and effective financial management procedures applied to ensure that full costs and loan obligations are met. To ensure that these objectives are met, the contract will be performance-based and progress will be closely monitored by the implementation consultants and the CPUC Board and management. A tripartite review will be carried out every 6 months, so that timely adjustments can be made. Eighteen months from the start of the contract, an in-depth review will be conducted to determine the personnel inputs for the remainder of the contract. 17

E. Economic Aspects 53. The economic internal rate of return (EIRR) was calculated for each subcomponent, except Pohnpei where a sector analysis approach was adopted. Economic costs included physical and nonphysical project components. In Chuuk, valued benefits include (i) restoration of electricity to households for whom no suitable or affordable substitutes for electricity exist; and (ii) replacement of the costs of self-generation by businesses and government entities with a reliable centralized public electricity at much lower cost. The EIRR of the Chuuk subproject is 11.2%. In Yap, valued benefits include (i) the provision of incremental water supply to residents in Maakiy and Maap, and (ii) the reduction in resource costs of supplying water to all consumers connected to the Gagil-Tomil well field operated by GTWA. The EIRR of the Yap subproject is 12.3%, slightly above the opportunity cost of capital of 12%. However, the subproject has substantial benefits that cannot be quantified, particularly the economic potential (tourism) opened for the Maap and Maakiy areas of Yap, which have been economically depressed due to lack of basic services, especially water. In Kosrae, the valued benefits include a substantial impact from the reliable delivery of treated, safe water to all consumers in the subproject areas. The EIRR of the Kosrae subproject is 16.2%. The Pohnpei subproject is a sanitation project, the benefits of which accrue to the community at large, and for which no explicit EIRR calculation is needed.28 The subproject is a least-cost solution to the sanitation and environmental problems, using technology appropriate to the cultural and social environment of Pohnpei, well within the capacity of the IA to operate and maintain, and consistent with government infrastructure development and environmental protection, policies, goals, and objectives. F. Environmental Aspects 54. The Project has no significant negative environmental impacts. The Project is in ADB's category B, requiring no EIA under ADB's environment policy, relevant operational procedures (OM/F1) and environmental assessment guidelines (2003). Continued review during detailed design is required by state government environmental policies, legislation, and regulations, and will be followed by the respective state governments. The respective state agencies have indicated that the IEEs of the subcomponents satisfy their preliminary environmental assessment requirements and that full EIAs are not expected to be necessary. Positive environmental benefits will accrue from improved wastewater collection and treatment in Pohnpei and provision of reliable power generation and distribution to Chuuk, allowing for improved wastewater and water supply services. Living conditions in all states will be improved by the respective infrastructure improvements. The Project also removes a major environmental hazard and health risk through the remediation of the existing Weno Island power plant site. Potential impacts related to siting have been addressed through a review of alternative sites and careful planning and design. Potential construction impacts are those typically expected for any construction activity, including erosion and sedimentation, traffic disruption, and noise. These will be mitigated by standard engineering practices and proper construction methods. Appropriate designs and training programs to support proper O&M address potential operational concerns. Preliminary environmental management plans (EMPs) for each of the four subprojects are attached to the summary initial environmental examination (IEE), and these spell out environmental measures that will be required of the final design, construction, and operations. The EMPs will be refined during the detailed design phase. The SIEE is included as Supplementary Appendix E. Appendix 14 gives a summary of SIEE findings and conclusions.

28 ADB. 2003. Key Areas of Economic Analysis of Projects. Manila. 18

G. Project Risks 55. Project risks center on (i) meeting CFA IDP requirements and availability of necessary CFA funds for counterpart financing, (ii) successful implementation of institutional reforms, and (iii) successful establishment of tariffs to recover costs. The Mission has closely coordinated project planning and design with the USDOI and other US agencies to ensure harmonization of approaches and institutional, financial management, and operational reforms. Widespread CPUC institutional reforms are necessary to successfully implement the Project in Chuuk. Recognizing this, CPUC has been instrumental in formulating a rehabilitation strategy for the sector, and has begun necessary reforms such as appointing a chief executive officer, rationalizing staffing functions and levels, installing prepayment meters, and improving billing and collection functions. Institutional reforms are also required in Kosrae and Yap to progressively centralize the ownership, and O&M of water supply systems. Government and public utility commitment to implement these reforms in both states has been demonstrated through dialogue with affected communities and local stakeholders throughout project development. Although Government and community land will be utilized for most project components, private land acquisition is required for the Kosrae component, and various planning and legal approvals are necessary for land parcels associated with the Pohnpei wastewater treatment facility, and also for the Chuuk power station. Both Pohnpei and Chuuk have commissioned a committee to work toward securing the relevant approvals. Water tariffs need to be established in Kosrae to recover costs for its subcomponents. There is a risk, initially, of public opposition to tariff establishment that could result in inadequate cost recovery and a need for excessive Government subsidy. Kosrae has demonstrated a strong commitment to develop tariffs and improve cost recovery, and is committed to implement public awareness and other initiatives relating to tariff establishment. The Project emphasizes building community and other stakeholder awareness and commitment to the Project, and is encouraging utility corporation responsiveness to community needs. V. ASSURANCES A. Specific Assurances 56. In addition to the standard assurances, the following further assurances have been incorporated into the legal documents: (i) CPUC will inform ADB of the progress and status of the OMM services contract as part of regular project reporting, and any substantive changes in the contract will be subject to prior agreement with ADB. (ii) CPUC will improve revenue collection so as to (a) recover 60% of outstanding arrears from residential and commercial sectors by 31 December 2005 and 90% by 31 December 2006, and (b) recover 90% of current billings from all customers by 30 June 2005. (iii) CPUC will complete annual reports summarizing its operations including technical, financial and managerial aspects within four months of the end of each fiscal year and make such reports available to the public, beginning with FY2004. (iv) The state of Kosrae will cause the transfer to KUA of (a) all state-operated water systems by 31 March 2005; (b) 50% of the municipal-owned and -operated systems by 30 September 2006, and the remaining 50% of the municipal water systems by 30 June 2006. (v) KUA will (a) conduct a sustained public relations campaign to raise customer awareness and willingness to pay for water by 30 June 2005; (b) introduce a residential tariff by 30 September 2006 to achieve 33% recovery of O&M costs for systems with treated water and incrementally increase to full cost recovery by 30 January 2010; (c) for systems with treated water, introduce tariffs at the cost 19

recovery level for commercial and government customers by 30 September 2006; and (d) maintain a customer relations program. (vi) The Government, Kosrae government, and KUA will (a) ensure that no entity, whether government agency, institution, or enterprise, regardless of ownership, will be granted an exemption from the tariffs established pursuant to the above, or granted a preferential rate, or excused for delays in payments without penalties; and (b) introduce appropriate measures to protect the basic living standards of the poor. (vii) By 31 December 2005, PUC will undertake a comprehensive tariff study for all services it provides, including wastewater services; and (a) identify appropriate charges for cost recovery of all services, (b) develop a transparent system for wastewater charges, and (c) develop recommendations for phased implementation of a tariff system that provides appropriate cost recovery for each service. The recommendations of the tariff study will be implemented with appropriate public and institutional consultation by 30 June 2006. (viii) Yap state government will ensure that appropriate legal measures are in place to ensure (a) that Maakiy and Maap communities are represented on the GTWA board of directors, and (b) that specific procedures ensure technical support to GTWA from DPWT and YSPSC, as necessary. (ix) The Government and state governments will ensure that the counterpart financing necessary for the Project is provided and disbursed on time to allow completion of project activities, and that additional counterpart funding is provided for any shortfall in funds or cost overruns. (x) The Government, state governments, and PUC, CPUC, KUA, and GTWA will ensure that all applicable government environmental laws, regulations, and standards, and ADB’s guidelines and procedures, particularly ADB’s Environmental Assessment Guidelines, are adhered to throughout project implementation and that all environmental monitoring and mitigation measures identified in the SIEE, the EMP, and the respective state governments' environment assessment processes are fully implemented. The Government, state governments, and PUC, CPUC, KUA and GTWA will further ensure that environmental mitigation measures are incorporated into design and bidding documents. The Government will monitor and record EMP implementation under the guidance and supervision of the respective state environmental agencies and will include monitoring information in project progress reports submitted to ADB. Preliminary EMPs will be revised during the detailed project design phase. (xi) The Government will ensure that all land and rights-of-way required by the Project will be made available in a timely manner, and in any event before civil works begin on the affected properties, and that the provisions of the short resettlement plan (SRP), including compensation and entitlements for affected persons, will be implemented in accordance with all applicable laws and regulations, and ADB’s Handbook on Resettlement. The Government will ensure timely provision of sufficient counterpart funds for land acquisition and resettlement activities, meet any obligations in excess of the SRP budget estimate, and ensure that any affected persons will be at least as well-off as they would have been in the absence of the Project. Adequate staff and resources will be committed to supervision and internal monitoring of the implementation of the SRP. The SRP will be updated as necessary to reflect any significant project material changes, including where the permanent site of the Chuuk power plant site requires land acquisition, and such changes will be subject to ADB approval. 20

B. Condition for Loan Effectiveness 57. The Government will have entered into relending agreements, in form and substance satisfactory to ADB, with at least three of the following entities: PUC, CPUC, state government of Kosrae, and state government of Yap. C. Conditions for Disbursement 58. The following conditions apply to disbursements for the Chuuk component only: (i) CPUC and Chuuk government will, through appropriate legal measures, have ensured that CPUC has the necessary, full, and unrestricted legal access rights onto private land to construct, monitor, and maintain power infrastructure and related components under the Project; (ii) CPUC will have completed the installation of prepayment electricity meters on every active Weno island power consumer, and improved revenue collection so as to have recovered 20% of outstanding arrears from the residential and commercial sectors, and 70% of current invoices from all customers (based on baseline status as of 30 April 2004); (iii) CPUC will have entered into the OMM services contract, in form and substance satisfactory to ADB; and (iv) the Chuuk government will have paid the arrears of each state government power account. 59. For disbursements on the Kosrae component only, (i) the Kosrae government will have caused enactment of state legislation designating KUA as the central water utility for Kosrae and providing for the transfer to KUA of all state-operated utilities and 50% of the municipal systems by September 2005, and the remaining 50% by 30 June 2006; the legislation will also provide for the development of a transparent performance-based subsidy system to KUA for shortfalls from tariffs; and (ii) KUA will establish, with adequate staffing, a division responsible for water and wastewater management, and appoint a suitably qualified division manager. VII. RECOMMENDATION 60. I am satisfied that the proposed loans would comply with the Articles of Agreement of Asian Development Bank and recommend that the Board approve (i) the loan in various currencies equivalent to Special Drawing Rights 9,686,000 to the Federated States of Micronesia for the Omnibus Infrastructure Development Project from ADB’s Special Funds resources with an interest charge at the rate of 1% per annum during the grace period and 1.5% per annum thereafter; a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan and Project Implementation Agreements presented to the Board; and (ii) the loan of $4,800,000 to the Federated States of Micronesia for the Omnibus Infrastructure Development Project from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s LIBOR-based lending facility; a term of 25 years, including a grace period of 5 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan and Project Implementation Agreements presented to the Board.

Tadao Chino President 13 October 2004 Appendix 1 21

SECTOR AND SUBSECTOR ANALYSIS

A. Introduction and Scope 1. This analysis summarizes the current status of the subsectors water supply, urban wastewater management, and power as the latter relates Chuuk State. No analysis has relevance to the (i) Asian Development Bank (ADB) policy initiative for the Energy Sector, Water Policy, related environmental policies, and country strategy; and (ii) indicators such as environmental quality and access to basic services. Lessons learned and the need for the Project are also presented. B. Sector Context 2. The Federated States of Micronesia (FSM), formerly part of the United States (US) Trust Territory of Micronesia, became an independent and sovereign nation in 1986 under a Compact of Free Association (CFA) with the US. The FSM consists of 607 islands spread over about one million square miles of the northern Pacific Ocean, and has four states: Yap, Chuuk, Pohnpei, and Kosrae. While most people of the FSM are generically classed as Micronesian, on the basis of ethnic and linguistic origins, cultures and languages differ markedly between states, and also between islands within some states. The resident population of the FSM increased slightly from 105,506 in 1994 to 107,000 in 2000.1 The 2000 population was 53,594 for Chuuk, 34,486 for Pohnpei, 11,241 for Yap, and 7,686 for Kosrae. The low population growth rate between 1994 and 2000 reflects the significant degree of emigration, especially to the US. 3. The infrastructure of the FSM is mostly concentrated on the “principal” islands, that is, on the islands of Kosrae, Pohnpei, the four closely grouped islands that constitute Yap Proper, and the Chuuk state capital of Weno Island. These islands have a combined land area of around 216 square miles, representing about 80% of the total FSM land area. Beyond the reefs enclosing the lagoons of Pohnpei, Chuuk, and Yap Proper lie the “outer” islands, comprising 39 municipalities in these three states, with an approximate average of one-half square mile of land area per municipality. In Yap, the outer island municipalities of Ulithi Atoll and Woleai Atoll are significantly larger than other outer island municipalities, and are more developed in terms of infrastructure than are any of the other 37 outer island municipalities. The level of development between the four states is uneven, with Chuuk, which has half the total population of the FSM, significantly below the national average. Lack of access to basic services, including water supply, sanitation, and electricity, are leading indicators of poverty in all states. C. Asian Development Bank Sector Focus and Country Strategy and Program 4. ADB initiatives in the energy sector2 emphasize (i) PSP to fund energy investments, (ii) energy efficiency on both the supply and demand sides, and (iii) closer integration of environmental considerations in energy development. In this context, ADB policies supported by the Project include (i) emphasis on economically sound infrastructure rehabilitation and system loss reduction, (ii) assistance in sector planning and training, (iii) active pursuit of environmental protection, and (iv) minimizing subsidies through tariff adjustments at regular intervals to fully cover the costs of supply. 5. ADB's water policy encourages support of integrated water resource management, improved and expanded delivery of water services, cooperation and awareness, regional cooperation, exchange of information, and improved governance. The policy emphasizes the need for autonomous management of water utilities, cost recovery, and PSP while ensuring access and equitable service to the poor and vulnerable. The Project supports this policy by

1 Extracted from the 2000 National Population and Household Census for the Federated States of Micronesia. 2 ADB. 1995. The Bank's Policy Initiatives for the Energy Sector. Manila. 22 Appendix 1 improving and expanding the delivery of water, reducing health risks, and encouraging good water and environment governance. It supports the continued development of Pohnpei Utilities Corporation (PUC) and Chuuk Public Utility Corporation (CPUC) in the wastewater and power sectors in Pohnpei and Chuuk, respectively; assists Gagil-Tomil Water Authority (GTWA) with system expansion; and supports the Kosrae government in developing the capacity of Kosrae Utilities Authority (KUA) to manage the water sector and introduce appropriate water charging policies. 6. The Country Strategy for 2003–2005 for the FSM takes into account the sector priorities and goals of the Government, and the outcomes of the CFA arrangements with the United States.3 The country strategy continues to support the Government strategy of private sector- led economic growth that creates an enabling environment conducive to private sector development which will create additional jobs and opportunities. Social sector development and reforms will continue to play an important role in the overall development of the FSM, with emphasis on improving basic social service delivery through increased allocation and better utilization of resources. A key objective is good governance through improved planning and budgeting systems, more effective and efficient utilization of resources, and transparent and uniformly consistent rules and regulations between and within the national and state governments. D. Indicators 7. In recent years, the FSM economy has stabilized and achieved a level of growth close to its long-run average real growth rate of about 1.5% per annum. This stabilization followed a significant reduction of CFA funding toward the end of the third 5-year period of the CFA. Economic activity declined in 2003 as a result of fiscal tightening in advance of reduced CFA assistance anticipated in 2004, and continued uncertainty and curtailed investment. Inflation in the FSM remains moderate, reflecting both the stagnant economy and low inflation in the US, the major source of imports. Negotiations for the new CFA have been substantially completed. The new arrangements include a $76 million grant and a $16 million contribution annually to the trust fund for 20 years. A minimum of 30% of the total must be used for infrastructure investment and 10% of this set aside for maintenance to ensure long-term sustainability of these investments. The FSM has prepared an infrastructure development plan (IDP) that projects $748 million for infrastructure during the period 2004–2023, with over 50% being sourced from CFA funds. 8. With a human poverty index of 26.7, the FSM has a low ranking in the Pacific. The incidence of economic inequality varies widely among the four states, and the lowest-income households are on the outer islands where employment opportunities are chronically lacking. The FSM also faces health and environmental issues related to inadequate access of the population to safe water, inadequate solid waste management, and loss of biodiversity. Maternal mortality of 122 deaths per 100,000 live births is a serious health issue and illustrates the poor quality of health services. Fertility rate decreased only marginally (for all women) from 4.6 children per woman in 1994 to 4.4 in 2000. However, for women in the labor force, the decline in fertility rate was much higher, from 3.4 children per woman to 2.5. Similarly, the crude birth rate decreased from 31 per 1,000 in 1994 to 28 per 1,000 in 2000. Life expectancy increased from 65 to 67 years while infant mortality rate (IMR) dropped from 46 per 1,000 in 1994 to 40 per 1,000 in 2000. Although there was a slight improvement in IMR, the decline was unsatisfactory as the rate is still considered one of the highest in the Pacific.

3 The Compact of Free Association (CFA) under which the US Government provides grant assistance to the FSM was recently renewed for a 20-year period. Appendix 1 23

9. Chuuk with half the population of the FSM has the lowest indicators, thus lowering the aggregate human development and poverty indicators for the FSM. In the Pacific human development index (HDI), the FSM ranks seventh of 12. On a global HDI scale, the FSM is ranked 120, which places it at the lower end of the middle ranking countries.4 On the human poverty index (HPI)5 of the United Nations Development Programme (UNDP), the FSM is ranked among the poorer countries of the world at 32 on the global scale. It has the fourth highest HPI in the Pacific, below Vanuatu, Solomon Islands, and Papua New Guinea. The state urban centers have access to a public water supply and sewerage. Public access to piped water at 97% (footnote 1) is highest in Kosrae but the small municipal water supply systems are in poor condition and the water is not potable. Yap has extended good quality water supply to most of the population on the large islands, while the outer islands have adequate water from wells and catchments. Yap has made the best progress so far in providing for the needs of rural consumers. In Chuuk, water quality is generally poor. On Weno island, ADB-financed investments have aimed at providing an island-wide treated water supply, but these have so far not achieved intended goals due to poor site selection and to some technical and management problems. Water-related diseases are a recognized health problem in all states. Health statistics profiles in each state show the incidence of amoebiasis, diarrhea, gastroenteritis, giardiasis, and some leptospirosis. However, the official records can only be regarded as indicative since they refer only to persons treated in hospitals and health centers. 10. The majority of the rural population in all states rely on untreated simple community systems, roof catchments, and small privately owned springs or wells, which may or may not be piped. Pohnpei, for example, has a reasonably good quality public water supply to urban and peri-urban areas, but water in the rural areas is not treated. PUC is systematically addressing the situation and the strategy to extend the treated piped water around the island is being advanced. This ADB loan, together with support from United States Department of Agriculture- Rural Utility Service,6 will provide treated water to all municipalities in Kosrae and coverage with a treated piped water supply to all municipalities in Yap Proper, except Rumung. In Weno (Chuuk), the available piped water system is not providing potable water at present, and systems on other islands provide only untreated water. 11. Only about 25% of the FSM population has access to either a sewerage connection or a septic tank (footnote 1), but this figure increases to over 70% for Kosrae. Sewerage systems are in place in Kolonia (Pohnpe), Weno (Chuuk), Colonia (Yap), and Tofol (Kosrae). However, none of them can be said to have an effective treatment and disposal system at present. In the case of Chuuk, the treatment plant has been out of operation for many years and raw sewage is discharged into the lagoon. No sewerage systems have been provided outside the main urban centers. The urban centers in all states have electric power. In Yap, Pohnpei, and Kosrae, electricity is also extended to a large proportion of rural residents. In Chuuk, however, the majority of rural households have no electrical power supply, and less than 20% of its total population have an electrical connection. Some have intermittent access via private or community generators or solar systems. Kosrae has the highest proportion of households with electricity connections (92%), followed by Pohnpei (65%) and Yap (56%). All states have reorganized their provision of electricity under public utilities corporations, and customers connected to the public electricity system are metered. Good progress on cost recovery is being made in all states, except Chuuk where the situation is only now being actively addressed.

4 The HDI is calculated from the average life expectancy at birth, adult literacy, gross school enrollments, and adjusted gross domestic product (GDP) per capita. A lower HDI number indicates a higher ranking. 5 The HPI is calculated by combining the percentages of people not expected to survive to 40 years of age, adults who are illiterate, people without access to safe water, and children under five who are underweight. 6 USDA-RUS support has been approved for water supply improvements for Lelu municipality, and an application has been made for support for water supply improvements in Malem municipality 24 Appendix 1

12. The IDP proposes substantial investment in water supply, and wastewater and power infrastructure during 2004–2023 with support from the proposed Project. The investment will particularly address the chronic deficiencies in the Chuuk lagoon islands where essential infrastructure is currently lacking. The IDP has allocated $141 million for water supply and wastewater infrastructure, and $81 million for power infrastructure. E. Institutional Framework: Laws, Policies, and Government Agencies 13. The national Government and the state governments have deemed it desirable for public utility corporations to have responsibility for power, and water supply and wastewater in their states, and have allocated these responsibilities in existing or pending legislation. This assignment is actively implemented In two states. Under the Project, the plan is for Kosrae to transfer water issues to KUA. The exception is the water sector in Yap, where centralization of the sector under the state utility Yap State Public Services Corporation (YSPSC) is stated as an eventual goal, but no definitive moves toward that have been made. The state is currently satisfied with the status quo, under which the Southern Yap Water Authority, YSPSC, and GTWA manage the sector jointly. The relevant legislation provides for continued autonomy of each of these authorities, but with a requirement for mutual cooperation. F. Evaluation of the Current Framework, Needed Reforms and Capacity Building 14. The current framework provides a strong foundation for improvements in the provision of water supply, wastewater and power services, and associated improvements in governance in these sectors. There is strong emphasis on capacity building for CPUC, KUA, and GTWA and on continued dialogue with PUC on tariff issues. Reforms under the subproject strongly support Government reforms of state-owned enterprises, particularly CPUC in the areas of financial management, training, and technical operations. There is a need to further integrate the water supply sectors in Yap and Kosrae, and to restore good governance in the power sector in Chuuk. Assistance in developing subsector management plans, regulations, and operational manuals are key capacity-building needs, particularly for the power sector in Chuuk. The framework supports targeted assistance to Yap and Kosrae in providing sanitation awareness programs, integrated with implementation of the water supply projects. G. Lessons Learned 15. This is the second ADB loan in the sector. Lessons learned from this experience, other ADB loans in the FSM, and the experience of other funding agencies include the following: (i) long-term capacity building and effective management systems need to be in place in the utility corporations for them to function effectively for project implementation and operations; (ii) detailed financial planning and management need to be implemented to ensure long-term financial viability of infrastructure investments; (iii) infrastructure component design, and operation and maintenance need to be appropriate for Pacific island conditions and constraints; (iv) land tenure matters are an integral part of project design and implementation; (v) early implementation of a community awareness program on issues such as water pricing and the health benefits of clean water will promote community support and willingness to pay for the service; (vi) community awareness of sanitation requirements should be integrated with water supply improvements if the desired health benefits are to be realized; and (vii) the use of local skills and training should be prioritized throughout project implementation to progressively develop local capacity to operate and maintain infrastructure. 16. The Project addresses these lessons through a variety of targeted interventions. Each of the public utility implementing entities of the four states, particularly CPUC in Chuuk will benefit from an operations, maintenance, and management support services contract to build capacity over an initial 5-year period, supplemented by technical assistance (TA) for capacity Appendix 1 25 building. In addition, KUA in Kosrae and GTWA in Yap will be supported through TA capacity building primarily related to financial and operational management. A thorough evaluation of financial planning has been performed for project implementing agencies in each state and tariff reform measures are specified to allow for progressive cost recovery to be achieved. Infrastructure components emphasize least-cost, low-maintenance solutions, and are appropriate for island environments. Land acquisition requirements have been kept to a minimum, and where land is required, acquisition of government and community-owned land parcels has been prioritized. Since land acquisition constraints on Chuuk are relatively acute, mobile power generation system components have been specifically proposed to provide flexibility in their interim and longer-term location. Community awareness programs relating to issues of water pricing and the health benefits of clean water, as well as a community sanitation awareness program are included in the project arrangements. The Project also supports the progressive development of local skills through training and capacity building. H. Need for the Project 17. The Project will contribute significantly to the improvement of public health and human development in all states. Proposed subprojects in Yap and Kosrae will supply potable water to households that currently lack safe water supplies, to reduce the incidence of waterborne and related disease in both states. Most households in the project areas of Yap do not have toilets and provision of water will encourage people to build toilets, especially if the state government makes them a public health priority. The Pohnpei subproject will improve public health and the environment in urban and peri-urban areas by upgrading the sewerage system. In Chuuk, the power rehabilitation project is justified on grounds of economic recovery, public health, and human development needs. Although it serves only the urbanized island of Weno, electricity is needed to pump water to consumers, for government operations, and for hospitals and schools. Rehabilitating the power sector will also facilitate the rehabilitation of the water sector.

26 Appendix 2

EXTERNAL ASSISTANCE

A. Other Funding Agencies 1. Table A2.1 lists ongoing or confirmed projects funded with external assistance in the water, wastewater, environmental and power sectors. Table A2.1: Non-Asian Development Bank Assistance to Relevant Sectors ($’000) Funding Project Name Agency Type Amount

UNDP Water Assessment and UNDP Grant 720.0 Development (1990–1996) Sanitation and Small Scale Water Project US EPA Grant 9,000.0 Small Scale Community Water Project AusAID Grant 30.0 (1990-Present) Community Water Supply and Sanitation New Zealand Grant 15.0 (1994-Present) Water, Power, and Sewerage Projects US DOI Grant 13,818.0 (1989-Present) Power Projects JICA Grant 2,000.0 Sewerage Projects JICA Grant 800.0 Outer Islands and Rural Communities EEC Grant 4,200.0 Renewable Energy (Proposed) UNDP = United Nations Development Programme, US EPA=United States Environmental Protection Agency, AusAID=Australian Agency of International Development, US DOI = United States Department of the Interior, JICA = Japan International Cooperation Agency, EEC = European Economic Commission. Source: Federated States of Micronesia Government. B. Asian Development Bank 2. Table A2.2 shows historical ADB funding for the urban management and urban infrastructure sectors. Table A2.2: Past Asian Development Bank Funding in Relevant Sectors ($ million)

Loan Year Number Loan Name Approved Amount

1459 Water Supply and Sanitation 1996 10.2 1520 Public Sector Reform 1997 17.9

Source: Asian Development Bank estimates. Appendix 3 27

PROJECT FRAMEWORK

Design Summary Performance Indicator/Target Monitoring Mechanism Assumptions and Risk Goals

High standard of public • Improved living standards Government monitoring health and the environment • Water-quality in new and programs and statistics through adequate rehabilitated systems meeting infrastructure World Health Organization (WHO) and local standards • Decline in water-related diseases decline

Economic growth and • Increased investments in all poverty reduction through states improved infrastructure, • Improved living standards particularly in Chuuk through improvements to the electrical power sector Objective/Purpose

Enhanced public health, • Effluent quality from Pohnpei • Pohnpei Utility • Solid waste environmental quality, and wastewater treatment plant Corporation (PUC) management surface water quality meeting Pohnpei Protection records project required to through improved Agency Environmental (EPA) • Pohnpei EPA utilize proposed site wastewater infrastructure standards by December 2008 monitoring reports proceeds as and management for • Occurrences of sewage • PUC financial scheduled Pohnpei and improved overflows reduced by 50% in management reports • PUC operation and delivery of water services Pohnpei by December 2008 and annual reports maintenance are and expanded water supply • Expanded wastewater • Utility corporation satisfactory. systems for Yap and collection systems to Sokehs water quality test • Infiltration into Kosrae; and improved serving additional 300 results sewer pipes is management and provision households by December • Yap, Kosrae, and reduced. of power in Chuuk 2009 Pohnpei health • Chuuk State • In Kosrae: Water systems statistics proceeds with water providing safe drinking water and wastewater in Mutunte (by September service 2006) and Walung (by June improvements upon 2007); and Utwe (by resolution of power December 2006) regularly generation providing safe (by WHO problems. guidelines and local • Sanitation standards) drinking Improvement • All households in Gagil-Tomil Program is (360 households) and Maap effective. (160) households in Yap with access to safe drinking water (by WHO guidelines and local standards) • Water-related disease statistics decline by 20% in Yap, 30% in Kosrae, and 10%in Pohnpei by January 2010

Continued on next page 28 Appendix 3

Design Summary Performance Indicator/Target Monitoring Mechanism Assumptions and Risk Poverty reduction, support • Continuous power supply to • Chuuk Public Utility • Continued for economic growth and all of Weno by December Corporation (CPUC) Government environmental 2006 data support improvements through • Increased number of visitors • Consumer feedback • CPUC reform improved power generation to dive resorts in Weno measures and distribution • 90% reduction in self- successful generation by connected • Satisfactory commercial and government maintenance of electricity customers facilities • 90% decrease in outages to residential customers by December 2006 • Cash power metering for all customers completed by 30 December 2004 • Tree clearing rights secured by CPUC by December 2004 • Work starting by December 2006 on Compact-funded rehabilitation of the water and wastewater sectors in Weno

Improved management of • Kosrae Utility Authority (KUA) • Project reporting and • State legislatures the water, wastewater, and established as centralized reviews pass required power sectors water utility for Kosrae by • KUA, Gagil-Tomil legislation. December 2004 with 2 Water Authority • Kosrae systems under its (GTWA), CPUC, and municipalities are management; 4 under PUC records and willing to relinquish management by end-2006; annual reports control of water and all systems under systems. management by end-2010 • Operation, • GTWA expands to include maintenance, Maap by June 2005 management • Water tariff established in services contract is Yap for full recovery of carried out as operation and maintenance designed. (O&M) costs by June 2005 and gradual increases to recover 30% of capital investments by January 2010 • Water tariff established in Kosrae by September 2005, as treated water is supplied, to achieve 33% O&M and incrementally increased to achieve full recovery of O&M costs by January 2010 • CPUC financially viable and power operations profitable by December 2005 • CPUC institutional strengthening program implemented throughout life of the Project • In Pohnpei, transparent recordng of wastewater management financial status recorded by December 2005 Continued on next page Appendix 3 29

Design Summary Performance Indicator/Target Monitoring Mechanism Assumptions and Risk Advancement of private • Decrease in system outages • Project reviews • Utility provision sector development by and consequent reduction in • PUC records improvements are providing improved self-generation by connected • Utility corporation sustained. infrastructure commercial and government records customers by December 2006 Outputs Component 1: Improved Power Infrastructure for Chuuk

Interim power-generating • 3 power units generating 3 • Installation and • Advanced action equipment megawatts (MW) installed by commissioning reports approved. December 2004 • Generator vendors have equipment available.

New power station and • Modular 7 MW power station • Project reports and • Project commissioning and commissioned by September review missions management is distribution system 2006 • CPUC reports effective. upgraded • Distribution system upgrades including, poles straightened and reseated, generators cleared of foliage, customer connections repaired and transformer loadings checked by December 2006 • Forced outages throughout the island reduced by 90% Remediation of old • Remedial investigation • Project reports and • Remediation works (existing) power plant site completed by June 2006 and review missions are affordable and to allow residential use remediation completed by • Remedial investigation meet EPA June 2007 report requirements. • EPA approvals • Remediation completion report CPUC as an effective and • CPUC written board • Project reports and • CPUC is receptive efficient power utility management policies and review missions to reforms. procedures established • CPUC annual and • State government is • Annual reports prepared and other reports committed to made public 6 months after • Training needs enforcing CPUC close of each fiscal year analysis and training right-to-land • Financial management reports access. systems improved by June • Financial records of 2005 CPUC • Written personnel management system developed and implemented by June 2005 • Management information system developed and implemented by June 2006 • Asset management system developed and implemented by June 2006 • CPUC prepared to address its mandates in water and wastewater services by December 2006 Continued on next page 30 Appendix 3

Design Summary Performance Indicator/Target Monitoring Mechanism Assumptions and Risk • Staff trained and retain strong capabilities in the assigned fields December 2007, including the following training and certifications (i) Financial management (and manual prepared) (ii) Business planning and administration (and manual prepared) (iii) Technical training in operation and maintenance of power systems (and manual prepared) (iv) Technical training in distribution line maintenance (linemen certification up to level III) (v) CPUC board trained in Commercial Board management and related manual prepared

Component 2: Improvements to Wastewater Infrastructure in Pohnpei

Wastewater treatment plant • WWTP providing at least • Project reports and • Solid waste and rehabilitated sand- secondary treatment review missions management extended sewerage system operating by December 2008 project is completed • 5 pump stations upgraded on schedule. • 1 new pump station • Connection • 3,200 feet (ft) of new and program is 5,000 ft of rehabilitated sewer enforced. collection mains • 5,700 ft force mains • 400 additional households connected by December 2009 Improved wastewater • Transparent tariff structure • Project reports and • Training programs management agreed and implemented to review missions are effective and allow transparent cost • Comprehensive tariff trainees recovery for sewerage review report responsive. system O&M, based on • Financing plans • PUC is able to comprehensive tariff review incorporating tariff increase tariff to • Training programs conducted structure cover sewerage with emphasis on effective • Training outlines and costs. O&M of new treatment facility reports and water quality monitoring; operators receive US EPA wastewater treatment plant operators certification by 31 December 2007

Component 3: Improved Water Supply Systems in Kosrae

Water supply systems in • Mutunte by June 2006 • Project reports and • Land acquired in Mutunte, Tafunsak, and (i) 414 gallons per minute review missions timely manner. Continued on next page Appendix 3 31

Design Summary Performance Indicator/Target Monitoring Mechanism Assumptions and Risk Utwe upgraded to provide (gpm) capacity slow • KUA records safe drinking water; and sand filter • Department of Health new safe water supply (ii) Chlorination unit water quality system provided to (iii) 180,000 gallon storage monitoring reports Walung, Tafunsak tank (iv) 23,900 ft new rehabilitated distribution lines • Utwe by November 2007 (i) 192 gpm capacity slow sand filter (ii) Chlorination unit (iii) 100,000 gallon storage tank (iv) 7,700 ft new and distribution lines • Walung by June 2007 (i) 5,800 ft transmission lines (ii) 20 gpm capacity slow sand filter (iii) Chlorination unit (iv) 9,184 ft new distribution lines

KUA established as • Legislation passed by • Project reports and • State legislature effective centralized water September 2004 to mandate review missions supports utility that KUA establish a water • Project reports and • Community leaders division to be the state’s reviews support Kea's central water utility with • Legislation management. powers to charge appropriate • Training needs • KUA takes tariffs for water and service; analysis advantage of subsidies provided, as • Training records available appropriate Operations and • KUA water division business Management plan and staffing completed Improvement by December 2004 Program (OMIP) • Staff trained and retain strong training programs. capabilities in the assigned • Effective design of fields December 2007, training programs including the following • Training and skills training and certifications are applied. (i) Financial management (and manual prepared) (ii) Business planning and administration (and manual prepared) (iii) Technical training in operation and maintenance of treatment and distribution systems (technical staff receive certificates from US Department of Interior OMIP, or equivalent)

Continued on next page 32 Appendix 3

Design Summary Performance Indicator/Target Monitoring Mechanism Assumptions and Risk Community awareness and • Awareness campaign • Project reports and • State government support of water implemented in Kosrae and review missions support conservation and Yap throughout the Project • KUA records • Implementation of acceptance of need • 80% bill collection efficiency • Community surveys associated TA to pay for water by June 2007 • All systems transferred to KUA by December 2010

Development and • State government or water • Published tariff study • State government implementation of tariff authority to agree on tariff • Water pricing policy commitment structure for water supply structure by March 2005 paper • Implementation of • Staged increase in tariffs to • Community awareness associated TA achieve O&M cost recovery program outlines and by December 2010 schedules • Community awareness programs on water charging to be undertaken during 2005

Component 4: Improvements to Water Supply Systems in Yap

Rehabilitated Gagil-Tomil • System expanded and • Project reports and • Capable water system and improved by December 2006, review missions contractors expansion of the Gagil- including: • Construction reports complete project Tomil System to Maap (i) 195,000 gal storage tank within time and (ii) 57,00 ft of transmission budget. lines (iii) 18,000 ft distribution lines (iv) One well developed in Maap

GTWA O&M and • O&M manual established by • Project reports and • Counterpart management strengthened December 2005 review missions availability • Training programs • Training needs • Training and skills undertaken with utility analysis and plan applied corporation by December • Design of training 2005 program effective Specific legal measures with detailed procedures to provide technical support to GTWA from Yap Department of Public Works and Transportation and Yap Public Service Commission by June 2005 Inputs

GTWA O&M and • O&M manual established by • Project reports and • Counterpart management strengthened December 2005 review missions availability • Training programs • Training needs • Training and skills undertaken with utility analysis and plan applied corporation by December • Design of training 2005 program effective • Specific legal measures with detailed procedures to provide technical support to GTWA from Yap Department of Public Works and Transportation and Yap Public Service Commission Continued on next page Appendix 3 33

Design Summary Performance Indicator/Target Monitoring Mechanism Assumptions and Risk by June 2005

• Community education • Department of Transport, • Project reporting • Consultant inputs programs Communications, and • Review missions effective • Project implementation Infrastructure (DTCI), State • Counterpart staff assistance governments, CPUC, PUC available and • Sanitation Program KUA and GTWA effective • Federated States of • PIA consultants, 71 person- Micronesia Government months international and 93 staff person-months domestic • State government staff consulting services • State utility corporations • 107 person-months • Management services international management contract consultants services contract consultants

34 Appendix 4

COST ESTIMATES AND FINANCING PLAN Table A4.1: Cost Estimates ($ million)

Foreign Local Percent of Item Exchange Currency Total Cost Base Costs Component A – Wastewater, Pohnpei 1. Sewer System Modifications 595,000 255,000 850,000 3.13 2. Causeway Lift Station 99,900 2,100 102,000 0.38 3. Lift Station Modifications 73,500 1,500 75,000 0.28 4. Wastewater Treatment Plant 3,279,770 1,274,330 4,554,100 16.78 5. Tertiary Wetlands 303,250 314,250 617,500 2.28 6. Allocation for Sokehs Sewerage System 1,750,000 750,000 2,500,000 9.21 7. Inflow and Infiltration 200,000 200,000 0.74 Subtotal (A) 6,301,420 2,597,180 8,898,600 32.79

Component B – Power, Chuuk 1. Land Acquisition for New Power Station 500,000 500,000 1.84 2. New Power Generation Station 6,062,800 162,200 6,225,000 22.94 3. Power Distribution Upgrades 814,605 78,967 893,573 3.29 4. Management Services 1,783,333 1,783,333 6.57 5. Power Station Remediation 692,850 692,850 2.55 Subtotal (B) 9,353,588 741,167 10,094,755 37.20

Component C – Water, Kosrae 1. Utwe Water System 502,558 228,382 730,940 2.69 2. Mutunte Water System 1,378,577 612,319 1,990,895 7.34 3. Walung Water System 481,348 208,442 689,790 2.54 Subtotal (C) 2,362,483 1,049,143 3,411,625 12.57

Component D – Water, Yap 1. Gagil-Tomil Rehabilitation 419,250 158,250 577,500 2.13 2. Maakiy, Maap Extension 1,743,807 709,649 2,453,456 90.4 Subtotal (D) 2,163,057 867,899 3,030,956 11.17

Component E – Project Implementation Assistance 1,226,110 473,755 1,699,865 6.26

Base Costs (A to E) 21,406,658 5,729,143 27,135,801 100.00

Contingencies 1,504,822 444,434 1,949,256

Project Cost (A to F) 22,911,480 6,173,577 29,085,057

Financing Charges 1,146,623 1,146,623

Total to be Financed 24,058,103 6,173,577 30,231,680

Notes: (i) Physical contingencies are 8% of base cost, excluding remediation. Contingencies for remediation assumed at 20%. (ii) Numbers may not add up to total because of rounding. Source: Asian Development Bank estimates. Appendix 4 35

Table A4.2: Financing Plan by Expenditure Category ($ million) Item ADB Government Total 1. ADF Loan a. Land 0.0 0.1 0.1 b. Civil Works 1.2 0.4 1.6 c. Equipment & Materials 10.0 2.5 12.6 d. Consulting Services 0.9 0.5 1.5 e. Unallocated (contingencies) 1.5 0.0 1.5 f. Financing Charge 0.5 0.0 0.5 Subtotal ADF 14.2 3.6 17.8 2. OCR Loan a. Land 0.0 0.4 0.4 b. Civil Works 0.4 1.5 1.9 c. Equipment & Materials 3.1 3.9 7.0 d. Management Services 0.0 1.8 1.8 e. Consulting Services 0.3 0.0 0.3 f. Unallocated (contingencies) 0.5 0.0 0.5 g. Financing Charge 0.6 0.0 0.6 Subtotal OCR 4.8 7.6 12.4

Total ADF + OCR 19.0 11.2 30.2 Percent 63 37 100 ADB = Asian Development Bank, ADF = Asia n Development Fund, OCR = ordinary capital resources. Note: Numbers may not add up to total because of rounding. Source: Asian Development Bank estimates.

Table A4.3: Financing Plan by State

ADB Government Total Source, State $ million % $ million % $ million % 1. ADF Loan a. Pohnpei 5.5 80 1.4 20 6.9 100 b. Chuuk 2.6 80 0.6 20 3.2 100 c. Kosrae 3.2 80 0.8 20 4.0 100 d. Yap 2.9 80 0.7 20 3.6 100 Subtotal ADF 14.2 80 3.6 20 17.8 100

2. OCR Loan a. Pohnpei 2.0 52 1.8 48 3.8 100 b. Chuuk 2.8 32 5.8 68 8.6 100 Subtotal OCR 4.8 39 7.6 61 12.4 100

Total ADF + OCR 19.0 63 11.2 37 30.2 100

ADB = Asian Development Bank, ADF = Asian Development Fund, OCR = ordinary capital resources. Note: Numbers may not add up to total because of rounding. Source: Asian Development Bank estimates.

PROJECT IMPLEMENTATION SCHEDULE 36

2004 2005 2006 2007 2008 2009

Project Activity Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Appendix5 Asian Development Bank Loan Period Loan Effectiveness Date Physical Completion Date Selection of Consultants Establishment of PMU Component A - Wastewater Infrastructure, Pohnpei Prepare Preliminary Designs Prepare Contract Documents for Construction Packages Tendering Inflow and Infiltration Study Improvements to Sewerage System Sokehs Island Sewerage System Modifications to Pumping Stations Wastewater Treatment Plant Constructed Wetlands/Effluent Disposal Pipeline Component B - Power Rehabilitation, Chuuk Advance Action: Emergency Power Generator Installation Preliminary/Final Design and Contract Documents Procurement of Management Support Tendering Prepayment Meter Installation Power Generation Station Power Distribution System Upgrades Existing Power Station Environmental Remediation Component C - Water Supply Improvements, Kosrae Preliminary and Final Design Tendering Construction of Mutente Water System Construction of Utwe Water System Construction of Walung Water System Component D - Water Supply Improvements, Yap Preliminary and Final Design Tendering Construction of Pipelines and Storage Rehabilitation of Gagil-Tomil System Component E - Sanitation and Training Hygiene Awareness Sanitation Improvement Program Component F - Project Implementation Assistance Project Implementation Assistance PMU = project management unit. Appendix 6 37

INDICATIVE PROCUREMENT PACKAGES Packagesa Item Mode Total Value Financed by ($ million) Number ADB (%) A. Component A – Wastewater, Pohnpei (Civil Worksb) 1. Wastewater Treatment Plant ICB 5.090 1 73 2. Sewer System Modifications ICB 1.148 1 73 3. Tertiary Wetlands LCBc 0.690 1 73 4. Sokehs Sewerage ICB 2.500 1 73 5. Inflow and Infiltration Study ICB 0.200 1 73 B. Component B – Power, Chuuk 1. Civil Works a. Power Generation Station LCB 0.613 1 50 b. Power Station Remediation ICB 0.817 2 50 c. Management Services ICB 1.783 1 50 2. Equipment and Materials a. Power Generation Equipment IS 5.338 2 50 b. Power Distribution Equipment ICB 1.344 2 50 C. Component C – Water, Kosrae (Civil Works) 1. Mutunte Water Supply System ICB 2.200 1 80 2. Utwe Water Supply LCB 0.809 1 80 3. Walung Water Supply LCB 0.771 1 80 D. Component D – Water, Yap (Civil Works) 1. Maap Water Supply System ICB 3.127 1 80 2. Maap Wellfield Developmentd LCB 0.221 1 80

E. Component E – Project Implementation Assistance ICB 1.770 1 80 ADB = Asian Development Bank, ICB = international competitive bidding, IS = international shopping, LCB = local competitive bidding. a Prices include 8% physical contingency for subprojects in Pohnpei, Kosrae, Yap and 6% in Chuuk. b Packages include equipment and material items, PUC may be able to bid for some packages. c Subject to availability of suitable local contractors. Contract documents as modified and changed by ADB. d Yap state may have capability of undertaking well drilling and development. Sources: ADB estimates. 38 Appendix 7

OUTLINE TERMS OF REFERENCE FOR PROJECT IMPLEMENTATION ASSISTANCE

A. Scope of Work 1. The consultant will work with the Executing Agency—Department of Transport, Communications and Infrastructure (DTCI)—and relevant agencies, i.e., the Department of Transportation and Infrastructure in Pohnpei, Department of Planning and Statistics in Chuuk and Kosrae, Office of Planning and Budget in Yap, Pohnpei Utilities Corporation (PUC), Chuuk Public Utilities Corporation (CPUC), the Gagil-Tomil Water Authority (GTWA), and Kosrae Utilities Authority (KUA), to undertake project management; develop all necessary plans and programs; and provide assistance, advice, and training for all activities undertaken under the Project as a whole and each of the subprojects. All activities will be carefully coordinated and integrated with the Compact of Free Association (CFA) infrastructure project management unit (PMU). B. Terms of Reference 1. Overall Project Management 2. The following project management activities will be undertaken: (i) Develop comprehensive project implementation and monitoring plans. (ii) Prepare a project performance monitoring system. (iii) Establish document control and contract management systems. (iv) Develop bidding documents and procedures based on the Asian Development Bank (ADB) Guidelines on Procurement. (v) Develop reporting procedures and reporting to ADB. (vi) Provide training and on-the-job guidance to the PMU on project management. (vii) Develop and assist in a project community awareness program in coordination with all implementing agencies. (viii) Develop a project accounting system. (ix) Develop project budgeting and forecasting systems. (x) Develop and conduct training programs for PMU personnel in the operation of the project accounting system and project budgeting and forecasting systems. (xi) Assist the PMU in financial management of the project in accordance with ADB's Guidelines for the Financial Governance and Management of Projects. (xii) Provide support and capacity building to the (CFA) infrastructure PMU. 2. Wastewater Improvements, Pohnpei 3. The following activities will be completed: (i) Prepare concept designs and performance specifications for a design-and-build contract for a 5.46 million liters per day sewage treatment plant. In coordination with PUC, conduct a condition survey of the existing sewerage system. (ii) Coordinate site preparation requirements and coordinate treatment plant construction schedule with the related solid waste management project that will be completed by Pohnpei. (iii) Identify a required rehabilitation program for the existing sewerage system and prepare a detailed budget for rehabilitation work. (iv) Establish a hydraulic model for the sewerage system using off-the-shelf software, and assist PUC to calibrate and operate the model. (v) Prepare detailed terms of reference for an inflow and infiltration study on the existing Kolonia sewerage system. (vi) Establish necessary laboratory upgrades and develop and conduct training programs for PUC in laboratory analysis of wastewater. (vii) In addition to training provided by the contractor, develop and conduct training programs for PUC in treatment plant operation and maintenance (O&M). (viii) Develop detailed designs and contract documents for modifications to the Kolonia sewerage system. (ix) Develop detailed designs and contract documents for construction of artificial wetlands area to polish secondary treated effluent suitable for direct ocean disposal. (x) Review the initial environmental examination (IEE) prepared under the project preparatory technical assistance (PPTA) and confirm its assumptions, conclusions, and recommendations. Appendix 7 39

Prepare a Government environmental assessment, if required. (xi) Prepare a final environmental management plan (EMP) and project environmental monitoring with appropriate details. (xii) Supervise construction and wastewater treatment plant commissioning. (xiii) Oversee decommissioning of the existing wastewater treatment plant and supervise the same. 3. Power Rehabilitation, Chuuk 4. The following tasks will be undertaken: (i) Develop detailed designs and contract documents for civil works for the new power plant. (ii) Develop equipment and materials specifications for distribution system rehabilitation works. (iii) Review the IEE prepared under the PPTA and confirm its assumptions, conclusions, and recommendations; prepare Government environmental assessment, if required. (iv) Prepare final EMP and project environmental monitoring with appropriate details. (v) Supervise construction and new power plant commissioning. In addition to training provided by the contractor, develop and conduct training programs for CPUC in power generation and distribution system O&M. (vi) Conduct remedial site investigation of the existing power station site, including site reconnaissance, subsurface exploration through soil sampling and groundwater sampling, hazardous building material sampling and testing, analysis and reporting. (vii) Assist CPUC with advance procurement of power generation equipment to provide auxiliary power on an emergency basis during the interim and until commissioning of the replacement power station. (viii) Assist CPUC with financial management system improvements, including personnel training. (ix) Develop an environmental remediation plan, and prepare designs. (x) Supervise soil remediation, handling and disposal of hazardous waste, asbestos abatement, lead-based paint removal as required, including sampling, laboratory testing, analysis, report preparation, and reporting. 4. Water Supply Improvements, Kosrae 5. The following tasks will be undertaken: (i) Develop detailed designs and contract documents for improvements to the water supply systems in Utwe, Mutunte, and Walung. (ii) Review the IEE prepared under the PPTA and confirm its assumptions, conclusions, and recommendations; prepare a Government environmental assessment, if required. (iii) Prepare the final EMP and project environmental monitoring with appropriate details. (iv) Develop bid packaging and manage bidding processes for all water supply improvement works. (v) Supervise construction. (vi) Develop and implement training programs for utility personnel for system O&M, including physical facilities and water quality monitoring. (vii) Assist KUA management to establish a viable water supply division within KUA, including developing policies and procedures, divisional business plans and budgets, office facilities and equipment, technical skills, and O&M manuals and procedures. (viii) Assist KUA in developing an appropriate tariff structure. Training should be coordinated with, and utilize as appropriate, available United States Department of Interior (USDOI) Operations and Maintenance Improvement Program (OMIP). 5. Water Supply Improvements, Yap 6. The following tasks will be undertaken: (i) Develop detailed designs and contract documents for the development of water systems in Maap and Rumung. (ii) Identify a rehabilitation program for the existing Gagil-Tomil water system and prepare a detailed budget for rehabilitation works. (iii) Conduct a detailed condition survey on the infrastructure to be retained from the existing Maap systems, recommend any rehabilitation works required, and prepare a detailed budget for the rehabilitation work. (iv) Review the IEE prepared under the PPTA and confirm its assumptions, conclusions, and recommendations; prepare a Government environmental assessment, if required. (v) Prepare the final EMP and project environmental monitoring with appropriate details. (vi) Assist the GTWA in technical operations and

40 Appendix 7 management by developing systems and procedures for equipment maintenance, water loss reduction program, system repairs, asset management, flow monitoring, and record-keeping. 6. Sanitation Improvement Program 7. Activities to be completed include government and community training on simple individual sanitation systems, and education and awareness programs for sanitation and hygiene. These are as follows: (i) Coordinate all activities under this program with the national and state departments of health and the Environmental Protection Agency in Yap. (ii) Identify appropriate and available individual sanitation systems for each state, particularly where water supply improvements will be conducted under the Project, i.e., Yap and Kosrae. (iii) Prepare planning, design, and construction brochures for the selected systems, which are suitable for the local audience. (iv) Provide training in planning (including site visiting), design, and construction of individual sanitation systems to staff of relevant agencies (as identified by the states). (v) Develop and modify existing sanitation and hygiene education and awareness materials for various media as appropriate for use nationwide and in the individual states, and translate materials into the local language. (vi) Develop and implement a community education and awareness program. (vii) Develop mechanisms and train local staff for long-term implementation of the awareness program. (viii) For all of the above, use and refine existing resources available locally and internationally to cost-effectively deliver the materials and maximize training and community contact time. C. Implementation Arrangements 8. The consultants will be recruited as a firm in accordance with ADB’s Guidelines on the Use of Consultants using the quality-based selection (QBS) method and full technical proposals. The following experts will be recruited to provide consulting services for 71 person-months (international) and 93 person-months (domestic): team leader-senior water and wastewater engineer, power engineer, water supply engineer, wastewater engineer, hydrogeologist, institutional specialist, financial management specialist, environmental specialist, construction management specialist, small-scale sanitation-community development specialist, computer- aided design (CAD) specialist, and public awareness-public relations specialist. The assistance will be provided over a period of 5 years beginning in January 2005 and ending in December 2009. DTCI will be the Executing Agency and primary Implementing Agency. The state agencies will be co-implementing agencies for their respective components. The Government will provide the following counterpart facilities at no cost to the consultants: office space, office furniture, and utilities (electricity, water, sanitation facilities, three telephone lines). Appendix 8 41

OUTLINE TERMS OF REFERENCE FOR CHUUK OPERATIONS, MAINTENANCE, AND MANAGEMENT SERVICES A. Overview 1. The need to strengthen the Chuuk Public Utilities Corporation (CPUC) institutionally has been recognized for many years, but previous attempts to do that through short-term technical assistance have largely failed. There is strong consensus at national and state levels, in the Asian Development Bank (ADB), and within CPUC management that a long-term commitment of support to the utility, sufficient to thoroughly rationalize CPUC’s human resources and to integrate appropriate management tools and procedures into day-to-day operations, is required to ensure that the utility can carry out its responsibilities sustainably. There is an immediate need to strengthen CPUC in the following priority areas: (i) personnel management, supervision, and training; (ii) metering, revenue collection, and financial management; and (iii) power system routine operation and maintenance (O&M). B. Outline Terms of Reference 1. Personnel Manager 2. The personnel manager will complete the following activities: (i) Conduct a thorough review of the human resource needs of CPUC, including analysis of required functions, capacities, and skills. (ii) Conduct a thorough review of existing staff qualifications and experience, and a performance assessment of existing staff relative to the needs of each position. (iii) Prepare a detailed assessment of training needs, and design a cost-effective strategy to meet them within the constraints of internal and external resources for training available to CPUC. The training program options should include, but need not be limited to, short-term training secondments within the Federal States of Micronesia (FSM) or overseas; longer term apprenticeship or senior-level professional courses in the FSM or overseas; "twinning" arrangements with other utilities in the FSM or overseas, and internal capacity for on- the-job training within CPUC. For technical operations (O&M of generation and distribution), provide means for all relevant personnel to achieve the minimum required certification, i.e., lineman certification up to at least level III, required certification for power station operators up to shift supervisory and station manager level; and certification for mechanics and electrical or wireman from technician to supervisory level. (iv) Review all current safety procedures and equipment and analyze needs for improvement. Recommend and assist in implementing safety awareness and procedures, and procurement and use of required safety equipment of internationally recognized standard. Prepare a comprehensive safety manual and train all technical staff in safety procedures. (v) Prepare a thorough analysis of needs and design procedures to strengthen management support to the Board, including format, timeliness, and quality of information provided to the Board from all CPUC division managers, analysis of impending issues, analysis of options and clear presentation of the recommendations of management. Design the procedures and format for recording Board deliberations and decisions and reporting these internally and externally as appropriate. Prepare a manual for CPUC that outlines all Board-related procedures and train senior management in applying such procedures. (vi) Through consultations with the Board, individually and collectively, clearly identify Board responsibilities and obligations by officer (chairman, secretary, etc.), design procedures and effective analytical methods for Board members to use in discharging duties in a timely manner, and prepare a manual for Board use describing such duties and methods. Consult with the Board individually and collectively to ensure acceptance and adoption of the recommended procedures; train new members in their use. (vii) Implement and supervise the training program approved by the Management and CPUC Board. (viii) Perform routine staff performance assessments, and give career counseling advice to staff as required.

42 Appendix 8

2. Financial Manager 3. The financial manager will complete the following activities: (i) Assume responsibility for the CashPower meter installation program to ensure rapid completion of metering for all CPUC electricity customers. (ii) Review current revenue collection, receipting, and banking procedures; implement strengthened procedures as required and train staff thoroughly in their use. (iii) Review the current financial accounting and reporting tools (including adequacy of software and computer hardware), and design and implement improved procedures as required; propose software and procurement of a management information system (MIS) as required within the internal and external resources for MIS available to CPUC. (iv) Implement and supervise upgrading of the MIS system as approved by CPUC management and Board. (v) Supervise the production of routine, semi-annual, and annual financial reports and accounts required for internal and external use, including an annual report. (vi) Assist in negotiation of renewal of major supply contracts as required, especially fuel, and monitor the performance of all current contracts and loan obligations. (vii) Maintain cash budgets to ensure adequacy of cash to avoid disruptions in ongoing operations. 3. Technical Operations Manager 4. The technical operations manager will complete the following activities: (i) Assume responsibility for technical operations of the power system, including generation and distribution components, and customer connections. (ii) Advise management of current or impending technical problems in the generation and distribution systems, and propose solutions with estimated costs. (iii) Monitor and supervise the performance of all outside contractors engaged in maintaining the new power station. (iv) Thoroughly review current procedures for power station and distribution system O&M and design and implement strengthened procedures as required. (v) Supervise monitoring of all control equipment and recording, storage, and transmission to management of operational data. (vi) Supervise the operation and control of CPUC stores; design and implement procedures for maintaining inventories to a professional standard. (vii) Ensure that the power station, stores, and external equipment of CPUC are maintained in tidy and serviceable condition at all times.

Appendix 9 43

OUTLINE TERMS OF REFERENCE FOR THE TECHNICAL ASSISTANCE A. Objectives and Scope 1. The goal of the technical assistance is to improve utility management and improve customer support for utilities in the Federated States of Micronesia (FSM) to make them sustainable, autonomous operations run on commercial principles. The foundations and systems will be established to promote private sector participation (PSP). The scope includes assistance to Chuuk Public Utilities Corporation (CPUC), Gagil-Tomil Water Authority (GTWA), and Kosrae Utilities Authority (KUA).

B. Terms of Reference 1. Chuuk Public Utility Corporation 2. The following activities to support the implementation of the training program identified by CPUC operations, maintenance, and management services contract will be completed: (i) Develop and implement written CPUC Board policies and procedures and a Board member training program, specific to power utility management. (ii) Implement staff training and certification programs, including an internal program and training through external resources. (iii) Procure software and equipment to implement an asset management program. (iv) Procure software and equipment to implement a management information system (MIS). 2. Yap and Kosrae Water Supply Community Education and Awareness 3. The consultants will assist the Kosrae government and KUA to implement the following: (i) Implement community consultations to develop a participative framework, and mechanisms for community awareness and education. The focus of the consultations will be on water pricing, the need to pay for and benefits of water supplies, and the advantages of a centralized water authority. (ii) Assess the information and education needs of the community, including identification of target groups such as municipal officials, community leaders, groups with special needs such as low-income and vulnerable households, women, and the socially excluded. (iii) Develop and deliver targeted information and education programs about water pricing, the need to pay for and benefits of water supplies, the advantages of a centralized water authority, and the Project and its benefits. (iv) Develop and implement a long-term public relations program within KUA to deliver community awareness programs and respond to customer concerns. C. Implementation Arrangements 4. The consultants for part B will be recruited as individuals in accordance with ADB’s Guidelines on the Use of Consultants, to provide 7 person-months international and 12 person- months domestic consulting services. The following experts will be recruited: A team leader- community awareness specialist and a public relations specialist. Assistance will be provided over 12 months beginning in March 2005 and ending in February 2006. For part A, the CPUC operation and maintenance (O&M) support contract consultants will be directly recruited to provide expertise in asset management, management information systems, and training program management. 5. The Department of Communication, Transport and Infrastructure will be the Executing Agency. The implementing agencies in each state will be as follows: CPUC in Chuuk, KUA in Kosrae, Planning Department in Yap, and Pohnpei Utilities Corporation (PUC) in Pohnpei. The Government will provide the following counterpart facilities at no cost to the consultants: office space, office furniture, and utilities (electricity, water, sanitation facilities, three telephone lines).

44 Appendix 10

SHORT RESETTLEMENT AND LAND ACQUISITION PLAN A. Scope of Land Acquisition 1. The Government’s policy is to avoid land acquisition and utilize government-owned land wherever possible. That approach has been followed in the project design and implementation. 2. The Chuuk government has allocated land for the short-term (5 years) site of the power plant. The long-term site remains to be identified and may be acquired during project implementation. Once identified, it will be acquired in accordance with the policies and regulations of the Asian Development Bank (ADB) and the Government. The state holds a clear title to the short-term site, which is in a safe unpopulated industrial space in the main harbor area. A portion of the site is being leased to a stevedoring operation, but is not affected by the Project. Another portion of the site has in the past been leased to a company whose operations are now defunct. The State intends to serve notice that the lease is terminated. The site has also been made available to several small businesses in a small market area. The operators sometimes live on the site, but have primary residences elsewhere. These businesses will be accommodated in adjacent areas owned by the state. 3. In Pohnpei, state land will be used for the wastewater treatment plant and all sewers, which are along existing roadways, and pump stations. 4. In Kosrae, land acquisition will be required for the water supply subcomponents, affecting about 15 landowners and about 1,600 square meters (m2) and a 1.5 meters (m) wide easement for a 1,750 m transmission line. Landowners hold legal titles and are not considered vulnerable by economic status, gender, or minority status. The land represents only portions of the landowners’ properties, if free of buildings, and is not in productive use or otherwise a source of livelihood. 5. In Yap, minor land acquisition is required—about 300 m2 and 2 m wide easement for a 3,170 m transmission line; however, this land is community property commonly held by the affected community. The allocation of these lands has been agreed upon by the relevant traditional leaders. 6. Total land acquisition will involve less than 15 landowners and 5 businesses. No permanent structures, sources of livelihood, or productive lands are affected. Thus, this level of land acquisition is considered insignificant by the ADB policy on involuntary resettlement and the Handbook on Resettlement. Only a short resettlement plan (SRP) is required. B. Consultations 7. The respective state governments have undertaken consultations with the affected persons (APs) and have assured in writing ADB of the disclosure of the SRP. The SRP will be posted on ADB’s web site upon Board approval of the Project. C. Policy Framework and Entitlements 8. The respective state governments have well-established procedures for land acquisition that consider traditional land tenure systems and formal land registration and transfer systems. Compensation and grievance procedures are well articulated in the relevant Acts and these are consistent with ADB's policy. Compensation is provided at market value (or agreed upon values since there is no significant real estate market) and grievance procedures range from administrative processes and hearings to court reviews. Appendix 10 45

D. Implementation Arrangements 1. Institutional Framework 9. The project management unit (PMU) will have overall supervision of land acquisition activities, while the individual state agencies will implement land acquisition as follows: Kosrae Department of Administration and Finance, Yap Department of Planning and Budget, Chuuk Public Utilities Corporation (CPUC), and Pohnpei Utilities Corporation (PUC). 2. Resettlement Budget and Financing 10. There are no land acquisitions costs for Pohnpei and Yap. For Kosrae, $40,000 has been allocated for land acquisition and this will be financed from state funds. For Chuuk there are no land acquisition costs for the short-term site of the power plant; however, a budget of $500,000 has been allocated for a long-term site, should land acquisition be necessary. 3. Implementation Schedule 11. Kosrae will begin land acquisition procedures by 31 October 2004 and expects to complete all land acquisition by 31 August 2005. If any other significant land acquisition or resettlement becomes necessary during the course of the Project, the Government will notify ADB. The Chuuk state government will specifically inform ADB of its land acquisition process for the power plant long-term site, which will be carried out in accordance with the state's and ADB’s policies and procedures. In all cases, the Government will ensure that land acquisition is in accordance with all applicable laws and regulations of the Borrower, and ADB’s policy on involuntary resettlement. E. Monitoring and Evaluation 12. Monitoring and evaluation will be mainstreamed into the overall project implementation. The monitoring program and quarterly reports will confirm the number of APs, status of the land acquisition process, and award of appropriate compensation. 13. The Government will ensure that all land and rights-of-way required by the Project will be made available in a timely manner, i.e., before civil works on the affected properties, and that the provisions of the SRP, including compensation and entitlements for APs, will be implemented in accordance with all applicable laws and regulations, and ADB’s Handbook on Resettlement. The Government will ensure timely provision of sufficient counterpart funds for land acquisition and resettlement activities meet any obligations in excess of the SRP budget estimate, and ensure that the APs will be at least as well-off as they would have been in the absence of the Project. Adequate staff and resources will be committed to supervision and internal monitoring of the implementation of the SRP. The SRP will be updated as necessary to reflect any significant material changes of the project scope, and such changes will be subject to ADB approval.

46 Appendix 11

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

A. Linkages to the Country Poverty Analysis

Is the sector identified as a national Yes Is the sector identified as a national Yes priority in country poverty analysis? priority in country poverty partnership No agreement? No

Contribution of the sector or subsector to reduce poverty in the Federated States of Micronesia (FSM): The sector contributes directly and indirectly to poverty reduction through the provision of basic urban services resulting in improved health and living conditions as well as potential for increased productivity and access to income earning opportunities.

B. Poverty Analysis Poverty Classification: Poverty Intervention1

Overall the people of the FSM are considerably less well-off financially than they were in 1994 due to changes in economic activity and reduction in government expenditure. The number of persons receiving income below $1,000 almost doubled from 1994 to 2000, while the median income of persons dropped by almost half in the same period. Chuuk has half the population of the FSM and the lowest social indicators, thereby lowering the aggregate national human development and poverty indicators. For example, 63.7% of individuals in Chuuk have incomes less than $1,000 per year according to 2000 census data, while the corresponding figures are 14.2% for Yap, 21.3% for Kosrae, and 20.6% for Pohnpei. The national poverty line is $867. Within the project area, an estimated 36% of the affected population live below the poverty line: 18% in Pohnpei, 54% in Chuuk, 18% in Kosrae, and 12% in Yap. The FSM ranks seventh of 12 on the Pacific human development index (HDI) while on a global HDI scale, the FSM is ranked 120th, which places it at the lower end of the middle ranking countries.2 On the United National Development Programme human poverty index (HPI),3 the FSM is ranked among the poorer countries of the world at 32nd on the global scale. It has the fourth highest poverty index in the Pacific. An estimated 15,000 or more people originating from the outer islands have settled on the major islands in each state over the past 40 years.

The Project provides direct poverty reduction by ensuring access to basic urban services to the poor through pro-poor tariff reform, and directing infrastructure improvements to poorer areas of the respective states. Further, the poor will benefit from income-generating opportunities associated with construction activities and the economic development that will ensue with reliable power generation in Chuuk. The table identifies the beneficiary populations of the subproject and the percentage of beneficiaries that are poor.

C. Participation Process Is there a stakeholder analysis? Yes No

Is there a participation strategy? Yes No

D. Gender Development

Strategy to maximize impacts on women: Women's organizations and representatives were consulted in all states. All expressed support for the project goals to provide potable water to consumers currently without, to improve standards of environmental sanitation in Pohnpei, and provide reliable power in Chuuk. It is recommended that the government include a representative of state women's organizations on the board of the public utilities authority so that women's views are represented and women can better understand the advantages of corporate organization for the provision of basic urban services.

Has an output been prepared? Yes No

1 Following the Board approval of the R-paper, Review of ADB's Poverty Reduction Strategy, staff instructions to replace the PI/CPI classification with a new tracking system are under preparation, in line with para. 83 of the R- paper. 2 The HDI is calculated from average life expectancy at birth, adult literacy, gross school enrollements, and adjusted gross domestic product per capita. A lower HDI number indicates a higher ranking. 3 The HPI is calculated by combining the percentages of people not expected to survive to 40 years of age, adults who are illiterate, people without access to safe water, and children under five who are underweight. Appendix 11 47

E. Social Safeguards and other Social Risks Significant/ Item Not Significant/ Strategy to Address Issues Plan Required None Significant Government land or community-owned land is available Full for project components in Yap and Kosrae. Minor land Resettlement Not significant acquisition or easements required for Kosrae will affect Short about 15 landowners, but no persons will need to be None resettled. All land is in nonproductive use and the None landowners are not socially or economically vulnerable or disadvantaged. In Chuuk, the short-term (5 years) power plant site is Government-owned and it is anticipated that the several small businesses presently holding leases on the site can be accommodated within the property or on adjacent Government-owned property. A long-term site for the power plant is still to be identified. Government land acquisition legislation in all states are well-established and consistent with ADB's Policy on Involuntary Resettlement. Therefore, a short resettlement plan has been prepared and is included in the report and recommendation of the President as Appendix 10. Significant The financial analysis demonstrated that existing and Yes Not significant proposed tariffs are within affordability levels of the No Affordability None affected populations. Significant No job loss will occur. The construction and operation of Yes Not significant the Project will generate employment opportunities to the No Labor None local beneficiaries. Significant The FSM has largely indigenous populations in each state Yes Indigenous Not significant and no minority population except for expatriate workers. No Peoples None Other Risks Significant No other risks of impoverishment were identified. Yes and/or Not significant No Vulnerabilities None

Beneficiaries and Percentage of Poor (2000) State Estimated Percentage Percent Estimated Estimated of Total Below the Affected Affected Affected Affected Project Poverty Poor Poor Item Population Households Beneficiaries Line (%)a Population Households

Pohnpei 0.29 Kolonia 5,681 902 17.5 995 158 Sokehs 2,835 450 17.5 496 79

Chuuk 0.50 Weno 14,739 1,965 54.1 7,980 1,064

Kosrae 3,700 514 0.13 18.1 670 93

Yap 0.08 Tomil 1,023 186 12.1 123 22 Gagil 734 133 12.1 89 16 Maap 592 108 12.1 71 13

Total 29,304 4,258 1.00 35.6 10,425 1,445 a National Poverty Line = $867/person/year. Sources: ADB. 2001. Poverty: Is it an Issue in the Pacific? Manila; ADB. 2001. Poverty Assessment in Pacific Developing Member Countries. Manila; FSM 2000 National and State Census. .

48 Appendix 12

SUMMARY FINANCIAL ANALYSIS

A. Financing Plan 1. The Project with an estimated cost of $30.2 million is proposed to be funded by the Asian Development Fund (ADF) ($14.2 million or 47%) and ordinary capital resources (OCR) ($4.8 million or 16%) of the Asian Development Bank (ADB) and through government counterpart contributions ($11.3 million or 37%). The national Executing Agency, the Department of Transport, Communications and Infrastructure (DTCI), with state implementing agencies (Pohnpei Utilities Corporation [PUC], Chuuk Public Utilities Corporation [CPUC], Kosrae Utilities Authority [KUA], and Yap's Gagil-Tomil Water Authority [GTWA]) will fund the Government’s 37%, comprising about $0.5 million in land purchases, about $7.8 million in civil works and materials or equipment from State funds, and a contribution of about $1.8 million from internal utility funds (Chuuk) to cover the cost of management services. 2. The Federal States of Micronesia's (FSM) current debt comprises (i) loans to the FSM Telecommunications Corporation with an outstanding balance of $26.3 million in FY2003; and (ii) ADB loans with a combined outstanding balance of $28.7 million in FY2003 for a water and sanitation loan ($8.8 million), a Public Sector Reform Program (PSRP) loan ($18.0 million), and Private Sector Development (PSD) Program and Project loans with outstanding balances totaling $1.91 million in FY 2003. In addition, there is an ADB Basic Social Services (BSS) Project Loan, which had not yet become effective in FY2003. However, the FSM has established an external debt sinking fund of offsetting assets that has sufficient resources to pay back all future debt service requirements under the PSRP, PSD, and BSS loans. These obligations are therefore not a liability to current Compact of Free Association (CFA) receipts or other current income. 3. The FY2003 debt was equivalent in raw measure to 24% of the gross domestic products (GDP) ($227.7 million) in the same year, and to 15% of GDP when external debt is adjusted for offsetting assets. The ADB PSD loan, which was negotiated and agreed upon with the Government before the negotiation on the second CFA with the United States (US) and hence at a time when the FSM’s future debt servicing capacity was uncertain, contains a covenant that the Government will limit external debt to 24% of GDP (its current level). However, now that the second CFA has been successfully negotiated at favorable levels, the Ministry of Finance will request that the covenant be lifted, and asserts that the FSM’s external debt and debt service levels are at very comfortable levels and should not constrain borrowing for economically viable projects.1 4. The national Government will enter into relending agreements with the respective state executing agencies for the proposed works in Chuuk and Pohnpei ($2.6 million from ADF and $2.8 million from OCR to CPUC in Chuuk and $5.5 million from ADF and $2.0 million from OCR to PUC in Pohnpei), and to the respective state governments in Yap ($2.9 million from ADF) and Kosrae ($3.2 million from ADF), on the same conditions as ADB’s ADF and OCR loans. The agencies will be responsible for repayments to the national Government as set out in the agreement.

1 Ministry of Finance, personal communication. Appendix 12 49

B. Government Institutional Reform and Implementing Agency Performance 1. Pohnpei Utilities Corporation, Pohnpei 5. Despite tariffs that have been raised substantially in recent years, PUC does not recover full costs in its combined operations. PUC is characterized by high depreciation costs due to its focus on three capital-intensive sectors: power, water, and wastewater. The current tariff levels recover a portion of these fixed charges plus operation, maintenance, and management (OMM) expenses, resulting in an adequate and continually improving cash position. Apart from minor connection fees, sewerage operations earn no direct revenues and thus do not recover cash operation and maintenance (O&M) expenses. However, in combination with the water supply sector, the OMM expenses of water and sewerage are fully recovered. The same water tariff is charged to all water users, whether they are connected to the sewer or not. 2. Chuuk Public Utilities Corporation 6. CPUC is wholly owned by the Chuuk State government and is responsible for power and water in Chuuk (though it currently operates only in the capital island of Weno and in nearby Tonoas), and for the sewerage system and wastewater treatment plant. In response to chronic financial losses and the need for cross subsidies to water and wastewater, the electricity tariff has been raised substantially in recent years and now exceeds the tariffs charged by many government-owned power utilities operating in other Pacific island developing countries. Water rates, however, remain well below the cost of supply and the losses are causing a severe financial drain on the utility. 7. The present Board has an excellent mix of senior government representation and commercial expertise. A new chief executive appointed in March 2004 has a good background in the public service and in the private sector, and has begun to implement urgent reforms, including a staffing review and collection of arrears. Despite these measures, the utility continues to operate with unsustainable losses. Resources allocated to maintenance are severely inadequate, and there are severe constraints on CPUC’s capacity to maintain the distribution system, obtain clear title to lands, and collect revenues fairly and equally from all electricity consumers. CPUC collects almost no revenue for the water supply and sewage treatment systems and is bearing high arrears and nonpayment from customers in electricity sales. Due to these constraints, electricity production has been unreliable, and production and consumption have declined significantly since 1995, and have followed a downward trend since 2000. 3. Kosrae Utilities Authority 8. The water supply in Kosrae consists largely of surface water systems under the operation and control of the municipalities, which do not meter or bill customers for consumption. To ensure affordability and sustainability of the production and distribution of treated water in Kosrae, the subproject will centralize the water sector and transfer its control KUA. All water customers affected by the subproject will be metered and billed for their consumption. 9. KUA was established in 1993, taking over from the Public Works Department (PWD) the responsibility for the supply of electricity throughout Kosrae. KUA currently employs 31 staff and each employee serves more than 45 customers, a raw indicator of efficiency that compares favorably with power utilities in the Pacific region. KUA has a well-functioning capacity in administration and financial management, which can accommodate water supply services as well as electricity. A suitable transition period, to allow consumers to gradually accept the need

50 Appendix 12 to pay for water and to allow time for an appropriate public relations campaign to take effect, is provided. 4. Gagil-Tomil Water Authority (Yap) 10. The GTWA was formed in 1986 to serve about 350 households and a few commercial and institutional customers from an abundant wellfield in the municipalities of Tomil and Gagil in the northern part of Yap Proper. The system, which is now about 18 years old, still supplies high-quality, potable water although its infrastructure has reached the end of its useful life and is beginning to decline. Water losses are increasing and require increased pumping. 11. Though GTWA has only 3 full-time staff members (a general manager, a financial manager, and a technical operations manager), the utility has operated well and community support for it appears to be high. The subproject includes technical assistance in training in financial management and maintenance. Recruitment of additional personnel for operations and administration will be required. C. Tariffs, Cost Recovery, and Project Financial Appraisal 1. Pohnpei Subproject: Wastewater Treatment Plant 12. Cost Recovery and Tariffs. The tariff for water customers in Pohnpei, implemented in 1996, is $1.80 per 1,000 gallons consumed. A portion of the revenues collected from water customers is used to cross-subsidize the sewage system, which is without an explicit sewer charge. As the sewerage system to be installed by the subproject is more efficient than the existing system, the current water tariff is sufficient to cover projected OMM costs for the two sectors combined. 13. PUC will conduct a comprehensive tariff review of all its operations including power, water, and wastewater in the later part of 2004, with assistance from the US Department of Interior. Based on the results and a dialogue with PUC management during implementation of the ADB subproject, the system for recovering charges for sewerage costs will become more explicit and transparent. 14. Financial Appraisal. As there will be, at this stage, no explicit charge for sewerage operations, the proposed subproject will not generate additional revenue. The financial internal rate of return (FIRR) will, by definition, be negative. 15. Financial Forecasts and Sustainability. PUC has performed well over the past 10 years, but does not recover full costs including depreciation. Cash balances are adequate to support operations and are expected to continue to improve; tariffs will shortly be reviewed and are likely to increase. The proposed subproject will improve operational efficiency and will have a neutral or slightly positive effect on PUC’s financial position for operations; the costs of OMM and finance charges associated with the subproject can be carried under current operations. 2. Chuuk Subproject: Power Sector Restoration 16. Cost Recovery and Tariffs. The current CPUC electricity tariff has rapidly increased during the past 5 years and was most recently raised in early 2004 to a level about double the levels prevailing before 1999. The current tariff is adequate to sustain operations and recover full costs; however, CPUC has a critical cash shortage because collection rates for electricity consumed are chronically low with high arrears. There is no significant cost recovery from water supply and sewerage operations. Appendix 12 51

17. Thus the urgent requirement for cost recovery and sustainability is not adjustment of the tariff, but improvement in revenue collection and cash management. The subproject includes measures to improve CPUC’s performance in these areas, which are discussed in a supplementary appendix. 18. Financial Appraisal. Cost recovery from the current tariff covers full costs, including OMM, capital charges, and finance costs, assuming rapid closure of the billings-collection gap (as discussed). Under that assumption, the FIRR of the subproject is 15.2%. The weighted average cost of capital, based on ADB loan terms (a blend of OCR and ADF) and the government savings rate, is calculated at 2.8%. 19. Financial Forecasts and Sustainabillity. CPUC will reverse chronic deficits and cash shortages, and begin to accumulate modest cash surpluses after completion of the subproject and implementation of associated institutional reforms. 3. Kosrae Subproject: Water Supply 20. Cost Recovery and Tariffs. At present, no charges are collected from water users in Kosrae.2 Although sustainability requires that all water consumers be metered and billed, if the health benefits of the subproject are to be realized, price must not deter local residents from using the water supply. Household surveys indicate that willingness-to-pay constraints in Kosrae, where water (though contaminated) is abundant, are significant. However, it is reasonable to expect that households’ willingness to pay will gradually adjust over time to the economic realities of the costs and benefits of a reliable treated water supply.3 21. Because the willingness-to-pay constraint in Kosrae is significant, there is a case for subsidizing the water sector to ensure that the expected public health benefits from the new system are realized. A tariff set to recover OMM costs only would require that the loan and debt repayment obligations be carried by the State government rather than the utility. The state government has given assurances of its willingness to assume the debt obligations of the subproject. To assist public acceptance of metering and billing for water consumption, it is proposed that the tariff be introduced in increments over the initial 4-year period (to 2009) following the start of the subproject. This would require a declining schedule of direct cash support for O&M during the first 3 years of the implementation period. 22. Financial Appraisal. At the proposed tariff for OMM recovery, the FIRR of the subproject is 11.5%. 23. Financial Forecasts and Sustainability. KUA has a history of sound operations, both technically and financially, and has accumulated substantial cash balances through its power sector operations to date. Costs to absorb the Kosrae water sector within KUA’s ongoing operations will be minimal. The assumption by the state of the debt obligations of the proposed loan for the subproject, the operation of the system by KUA under the proposed OMM-recovery water tariff, implemented in increments and combined with an initial cash subsidy as proposed, will have a neutral or slightly positive effect on KUA’s financial position. 4. Yap Subproject: Water Supply 24. Cost Recovery and Tariffs. The existing GTWA water tariff reflects a recent (January 2004) increase equivalent to the urban water tariff (Colonia). The current tariff is sufficient to

2 Some municipalities levy a minor ($2/month) flat rate charge. Collection rates even on the flat rate charges are reportedly low. 3 Project implementation arrangements include community awareness programs on the costs of supplying treated water and on the need to pay for water.

52 Appendix 12 recover OMM costs of the expanded system once all elements are completed. It is proposed that the loan and debt repayment obligations for the subproject be carried by the state government; the state has given assurances to this effect. It is further proposed that a portion of capital costs (up to 30%) be recovered from users and reimbursed to the state through modest increments in the average tariff over the 8 years grace period of the loan. 25. Financial Appraisal. The existing and recommended tariff provides for recovery of OMM costs and only partial recovery of capital costs. The FIRR is 4.7%. 26. Financial Forecasts and Sustainability. GTWA has conducted good technical operations over 18 years, has a high degree of consumer and community support, and has implemented tariff increases together with enforcement of a disconnection policy to ensure financial sustainability. The subproject will improve efficiency and reduce unit costs while providing for an expansion to presently unserved areas. The assumption by the state of the debt obligations of the proposed loan for the subproject, and the operation of the system by GTWA under the current tariff, with modest increments implemented as proposed, will have a neutral or slightly positive effect on GTWA’s financial position and enable it to reimburse the state for a portion of capital costs over time.

Appendix 13 53

SUMMARY ECONOMIC ANALYSIS 1. The Federated States of Micronesia (FSM) is a federation of four states (Chuuk, Kosrae, Pohnpei, and Yap), each with its own government, language(s), culture, and identity. More than 600 islands scattered over a distance of around 3,000 km from west to east have a population of just over 107,000 (2000): 11,241 in Yap (11%), 34,486 in Pohnpei (32%), and 7,686 in Kosrae (7%). About half the population live in Chuuk (53,595) but of these, only about 14,500 live in Weno, the state capital. Real gross domestic product (GDP) growth declined significantly from 1995–1998 due in part to planned reductions in support from the United States (US) Compact of Free Association (CFA) and, despite a modest upturn thereafter, real GDP in 2001 was still below that of 1995. Real per capita GDP has likewise stagnated at slightly more than $2,000 (in 1998 dollars). In 2004, a new Compact Agreement was implemented, with economic stabilization measures and access to long-term infrastructure development support, which should ease financial strains and improve productivity. 2. With the exception of the Pohnpei subproject (paras. 3–9), the economic analysis of subprojects compares a calculated economic internal rate of return (EIRR) for the subproject to the economic opportunity cost of capital (EOCC), which is assumed to be 12%. A. Pohnpei Subproject: Wastewater Treatment Plant 1. Economic Rationale 3. The main island of Pohnpei State is the seat of the national Government and home to about 32,000 people or 32% of the FSM population. The sewerage collection and wastewater treatment systems serve the Kolonia area (population about 5,700). The sewerage collection system is old and leaky and overflows during heavy rain, contaminating adjacent residential areas and creeks. Partially treated effluent is discharged into the harbor by a short outfall pipe located near public recreational areas. The subproject is designed to improve the sewerage collection system and curtail contamination from overflows, and provide a new wastewater treatment plant for safe disposal of fully treated effluent. 4. Because of old and degraded wastewater system, inadequately treated and untreated sewage adversely affects the Kolonia harbor area. Water quality monitoring in the harbor by the state Environmental Protection Agency (EPA) shows consistent and substantial exceedance of established limits for waste-related parameters. The EPA water quality standards conform to accepted international standards such as those mandated by the US EPA and World Health Organization (WHO). EPA conducts regular water quality monitoring at about 15 sites around the harbor, as well as in other coastal areas of Pohnpei. The proposed subproject is the key element of EPA’s strategy to improve water quality in the harbor. 2. Project Description and Beneficiaries 5. The Pohnpei subproject consists of an improved wastewater collection and treatment system for the Kolonia urban area, including a gravity sewer, effluent transmission line, two force main sewers, a sewage lift station, rehabilitation of the existing sewer collection network, modifications to two lift stations, possible expansion of the sewerage system to the Sokehs district, construction of an activated sludge wastewater treatment plant and tertiary constructed wetlands, and an inflow and infiltration study. 6. The subproject will improve environmental conditions, reduce health risks, and enhance aesthetic environment of the residents and thousands of visitors that annually come to Kolonia Town and parts of Nett, Sokehs, and Utwe. It will particularly benefit the 2,800 residents of

54 Appendix 13

Sokehs island, the coastal waters of which are heavily polluted due to inadequate arrangements for effluent disposal in that area. 3. Project Selection 7. The present and currently the only available site is bounded by private land which is not available to the subproject. The least-cost option appropriate to the local environment and site therefore utilizes an activated sludge plant and constructed wetlands before effluent disposal into the mangroves. The design also results in low operation and maintenance costs as the system takes advantage of a low-elevation site to minimize pumping requirements. 4. Economic Analysis 8. The economic analysis follows relevant Asian Development Bank (ADB) guidelines. Using an approach that is more appropriate for most wastewater management projects than standard cost-benefit analysis, it does not include valuation of benefits or calculation of an EIRR. Instead, wastewater management is viewed as part of a strategy for protecting and improving ambient water quality. The economic rationale is based on sector analysis and examines the least-cost approach to achieving environmental objectives. 5. Results and Conclusion 9. The ambient water quality standards in force in Pohnpei and the associated infrastructure development plans established to meet them (including the proposed subproject) are a reasonable approach to managing environmental protection and ambient water quality and planning for sustainable urban development. The subproject is a critical component of Pohnpei’s strategy to achieve water quality targets and represents a least-cost approach to doing so, in terms of both capital and operational costs. Broad public support for environmental improvements and water quality protection has been demonstrated by public participation. B. Chuuk Subproject: Power Sector Restoration 1. Economic Rationale 10. Weno, the capital island of Chuuk State, is the seat of government and the location of most of the economic and social service activity serving and employing the people of Chuuk. The existing power system consists of a diesel power station and distribution system which, due to inadequate maintenance, are close to inoperability. Extended outages of electricity in Weno are common occurrences and a continuation of these and a worsening of deterioration will result in substantial damage to Weno and Chuuk State as a whole. The Chuuk subproject will fully restore power capacity to Weno, refurbish the overhead distribution system, and provide essential and long-term support to Chuuk Public Utilities Corporation (CPUC) to ensure that the restoration is sustained and cost-efficient to the provider and to consumers. 2. Project Description and Beneficiaries 11. The Chuuk subproject has three components: (i) a replacement power station with capacity sufficient to meet peak demand over the next 20 years; (ii) clearing of power distribution system backlog maintenance and provision of necessary institutional support; and (iii) environmental remediation of the existing power station site. The subproject will benefit about 2,290 government, residential, and commercial consumers comprising all of the approximately 14,500 residents of Weno Island, improve the lives of the people, and reduce their expenditure on lower-quality sources of energy. Appendix 13 55

3. Project Selection and Analysis of Alternatives 12. Two alternative power generation solutions have been identified and evaluated: (i) a power generation station utilizing a series of movable, modular diesel engine-generator power units; and (ii) a power station of conventional stationary design, utilizing larger power units. The modular power station provides distinct advantages in flexibility and cost and will provide a reasonable reserve margin and similar operational efficiency as the stationary option. Measures to ensure substantial improvements in power system management, operation, and revenue collection (including the installation of prepaid meters for all customers) are an integral part of the subproject (see supplementary appendixes). 4. Economic Analysis 13. The valuation of the subproject’s benefits varies by customer category, as the various categories’ access to close substitutes for electricity varies substantially. 14. For the residential sector (households), the gross benefit of electricity is the value of consumption at the current tariff plus an estimate of the consumers’ surplus for electricity at the current tariff. Data to determine consumers’ surplus in Weno are not available since billing records are incomplete. This analysis is therefore based only on the valuation of residential consumption at the current tariff without consumers’ surplus, and is therefore an underestimate. For commercial and government consumers, loss of electricity from the public power supply can be substituted by self-generation. The gross benefit to these sectors is therefore the kilowatt- hours (kWh) made available with the Project, multiplied by self-generation cost per kWh, as a proxy for willingness to pay and for the resources that would have to be employed to supply the same kWh without the Project. 15. Nonquantifiable benefits include the value of social services (e.g., public administration, health and education services, and public safety) that are curtailed for lack of electricity; loss of investor confidence in the local economy and reduction in investment and growth in the economy; loss of incomes due to loss of employment and ability to market goods; a measure of consumers’ surplus and loss of the standard of living that affordable electricity can provide to households, especially the poor. 5. Results and Conclusion 16. The EIRR is 21.78% and is generally robust to reasonable adverse changes in estimated (i) capital cost, (ii) gross benefits, and (iii) a combination of adverse changes in capital costs and gross benefits. C. Kosrae Subproject: Water Supply 1. Economic Rationale 17. Kosrae is a single island and has the smallest population of the FSM states. The population is predominantly rural and well distributed throughout the coastal areas. The existing water supply consists of small-scale municipal surface water collection and distribution systems. The population depends on these systems which, due to a combination of poor watershed management and inadequate sanitation facilities, are heavily contaminated. The incidence of waterborne and water-related diseases is consequently high. 18. The subproject will provide the people in affected areas with an efficiently managed and treated water supply of high reliability, operated and managed by the Kosrae Utilities Authority (KUA). The primary rationale for the subproject is treatment of water, reduction of waterborne contaminants, and consequent improvement in public health.

56 Appendix 13

2. Project Description and Beneficiaries 19. The Kosrae subproject consists of infrastructure improvements and upgrades for the Mutunte, Utwe, and Walung water supply systems, including (i) new or rehabilitated intake structures; (ii) repairs to the existing transmission pipelines; and (iii) for each system, provision of a sedimentation tank, slow sand filtration treatment plant, clear well reservoir, chlorination facilities, increased water storage, pumping facilities, and rehabilitation of the distribution network to provide adequate pressure throughout the system. A combined population of about 3,700, equivalent to nearly 50% of the total population of Kosrae, will benefit directly from the subproject. The subproject will ensure that water supplied to affected households will meet or exceed EPA standards for drinking water. 3. Project Selection and Analysis of Alternatives 20. As the Kosrae subprojects largely include rehabilitation of existing systems, analysis of alternatives analysis is inappropriate as the proposed components primarily are replacement of existing equipment and materials, and added treatment systems that are inherently least cost. 4. Economic Analysis 21. The economic benefits of improved public health include reduction in the costs of treatment in the local health care service and overseas and reduction in fatalities (benefits that are quantifiable), and reduction in work or schooling time lost by patients afflicted with water- borne diseases (not quantifiable, but significant). 5. Results and Conclusion 22. On the basis of para. 21, the EIRR of the subproject is estimated at 16.2% with an associated net present value (at a 12% discount rate) of $1.0 million. Sensitivity tests of an increase in capital costs by 20% and a decrease in the value of benefits by 20%, gave EIRRs exceeding 12%, while combining an increase in capital costs and decrease in benefits by 20% resulted in an EIRR of slightly below 12%. D. Yap Subproject: Water Supply 1. Economic Rationale 23. The rural Tomil, Gagil, and Maap municipalities of Yap Proper have poor soils and relatively limited economic opportunities. Some 350 households in Gagil-Tomil have been served for about two decades by a high-quality piped water supply from an abundant well field, making most of Gagil-Tomil a habitable area suitable for further development. About 150 households in Maakiy and Maap depend on limited and contaminated surface water resources and rainwater catchments. Reliance on these sources constrains water consumption, increases health risks, and reduces the quality of life and economic opportunities in the affected areas. 24. The subproject will (i) refurbish the existing Gagil-Tomil water supply system and reduce water losses and production costs; and (ii) extend pipelines to Maakiy and Maap from the Gagil- Tomil wellfield to provide those communities with reliable treated water. The improvements will reduce poverty and improve the habitability of the area and indirectly will improve prospects for economic development in Maap, especially in tourism, and provide more sources of income. Appendix 13 57

2. Project Description and Beneficiaries 25. The Yap subproject consists of piped water supplies to Maakiy and all villages in Maap, and rehabilitation of the existing Gagil-Tomil water supply system. The subproject will benefit three municipalities with a total population of about 2,500. 3. Project Selection and Analysis of Alternatives 26. Two options were considered, both directed toward serving the Maap and Maakly areas. These are (i) piped water to expand the existing Gagil-Tomil water system and to supply Maakiy village and the villages of Maap; and (ii) a multiple water supply system consisting of an independent piped water system for Maap including development of a wellfield on Maap, together with piped water expansion from the Gagil-Tomil wellfield to supply Maakiy village. Since surface water is limited and receives only minimal treatment, i.e., disinfection is needed for the available groundwater, comparison of technology options is not relevant. 27. The least-cost analysis of the options noted above is not straightforward as the beneficiary populations are not equivalent and technical and operational management concerns do not warrant inclusion of additional systems to make beneficiary populations equivalent. The initial cost of operations exceeds that of plan Z by about $0.8 million, although the present value of lifecycle operation, maintenance, and management (OMM) costs for the integrated option is estimated at about $0.1 million less than the multiple system option. The integrated system option features a more streamlined and integrated management under one Authority, which promotes operational efficiencies and improved financial management, provides for security of supply from a proven well field, and allows for expansion in a larger geographical area. Therefore, the selected option is financially and economically the most efficient option and provides the most appropriate solution for operation and maintenance (O&M) and future needs. 4. Economic Analysis 28. The valuation of economic benefits is based on measurable (i) reduction in waterborne diseases among the population in the project area; (ii) reduction of water losses and increasing operational efficiency in Gagil-Tomil Water Authority (GTWA), which result in lower real costs; and (iii) extension of incremental reliable, safe water supplies to the populations of Maakiy and Maap. 5. Results and Conclusion 28. The analysis results in an estimated EIRR of 12.3%. Significant additional albeit unquantifiable benefits strongly support implementation, (i) a strong expectation that without the project, water contamination and incidence of waterborne diseases in the project area will increase substantially in the future without the project due to population pressures and continuing deterioration of the existing water supply systems; and (ii) a substantially increased scope for residential settlement of the area by people from other overcrowded or economically marginal areas of Yap including the outer islands,1 and for development of tourism. The water supply is presently the chief limiting factor in such development, as the area is already reasonably well served with roads and electricity.

1 A government-supported settlement program, mainly benefiting inhabitants of depressed areas of the outer islands, is presently under way, with three new settlement areas opened in Gagil-Tomil and adjacent areas where water is available. Access to a safe and reliable water supply in northern Gagil and Maap will permit increased settlement and encourage many former residents in those areas who now reside in Colonia due to lack of water, to return.

58 Appendix 14

FINDINGS AND CONCLUSIONS OF THE SUMMARY INITIAL ENVIRONMENTAL EXAMINATION

A. Introduction 1. An initial environmental examination (IEE) was carried out for each of the four subcomponents. A summary IEE (SIEE) was prepared for the Project as a whole. B. Description of the Environment 2. The SIEE and IEEs for the respective project subcomponents fully describe the environment. The four states have a prevailing tropical climate. Rainfall is generally high, ranging from around 300–450 centimeters (cm) in Yap and Chuuk, and about 500 cm annually in most parts of Kosrae and Pohnpei. Other biophysical conditions within the project implementation areas are varied, as follows: (i) Pohnpei. The proposed site for the new sewage treatment plant is the existing solid waste dump site on Dekehtik Island, which also has the airport, bulk fuel storage tanks, and light industrial activities. Mangroves are the predominant vegetation in the undisturbed areas. The area adjacent to the proposed project site is a heavily silted shallow reef flat, covered with mud and coral rubble. (ii) Kosrae. Three perennial streams are the source waters for the water supply subprojects. These are Palusrik stream in Utwe municipality; and Mutunte and Lemwot streams (Walung) in Tafunsak municipality. The Mutunte and Utwe systems will use existing intake structures and Walung will require a new intake structure. The watersheds in these areas are similar, covered with fairly dense vegetation. The streams are host to a limited assemblage of native fishes and invertebrates. The water treatment and storage systems are located below the intakes. The Walung site is in a disturbed area adjacent to the community school, and the Utwe and Mutunte treatment systems are located close to existing settlements. The distribution pipeline routes follow existing alignments. (iii) Yap. The project area for water supply improvements includes a site on Maap for development of a new groundwater well plus several planned storage tank sites and distribution pipelines. Much of the environment is characterized by savannah areas that host a sparse assemblage of native plants. In the lower-lying areas where wells would be drilled, broadleaf vegetation dominates. Alignments for new distribution pipelines will follow existing road alignments and walking tracks. (iv) Chuuk. The site for the new power generation facilities is at the existing TRANSCO site in the dock area. This is a developed urban site that is surrounded by other industrial uses. Improvements to the power distribution system will be on existing lines and equipment, and will not encroach into any new ecologically sensitive areas. C. Alternatives 3. A number of different site and design alternatives were considered for each of the proposed subprojects. The preferred alternatives were selected based on a range of considerations: technical, institutional, economic, and environmental. D. Anticipated Environmental Impacts and Mitigation Measures 4. Environmental analysis identified the potential impacts that might occur with implementation of the subprojects. Mitigation measures were identified and recommended to avoid or minimize the adverse impacts. The potential adverse impacts, and the recommended Appendix 14 59 mitigation measures to counteract them, are presented in the following table. Details are the SIEE and environmental management plans (EMPs).

Table A14: Potential Impacts and Mitigation Measures

Project Phase Potential Effect Mitigation Measures Pre- Kosrae and Yap Kosrae and Yap construction Encroachment into ecologically sensitive areas Buffer zones maintained around stream beds to (design) Increased sewage production. protect water quality Sound watershed management practices initiated Water conservation programs implemented Sanitation improvement program included in the Project Chuuk Chuuk Location of plant at site near sea level Site "climate-proofed" with appropriate protective exposed to storm waves and flooding structures Excessive noise production by generators Site selection and equipment specifications Excessive spillage of fuels and lubricants selected to minimize noise generation and transmission Equipment specifications and spill control prevention plans minimize spillage Pohnpei Pohnpei Sewage overflows and bypasses System designed to minimize overflows and Effluent not meeting receiving water standards bypasses Inadequate sludge treatment and disposal Effluent treatment design to comply with existing Sulfide corrosion of sewage collection pipes discharge standards; operation and maintenance training provided System design allowing for adequate sludge removal and treatment and disposal at sanitary landfill Specifications for corrosion-resistant pipes Construction Kosrae, Yap, Chuuk, and Pohnpei Kosrae, Yap, Chuuk, and Pohnpei Soil erosion in exposed work areas Use of silt curtains or other mechanical devices to Occurrence of construction-related hazards limit silt and soil runoff, as appropriate Impacts to ecology or cultural resources due to Excavations covered between construction inadequate monitoring (Kosrae and Yap) Workers trained in appropriate safe working Localized clearing of vegetation (Kosrae and practices safety equipment made available as Yap) necessary Traffic, noise, odors and dust (Pohnpei and Consultations with biologist and archaeologist Chuuk) during construction, if required Social impacts, worker conflicts Vegetation clearing minimized as practicable Construction plans to include best management practices to minimize traffic, noise, odors, dust Workers obtained from local workforce, where practicable Operational Kosrae and Yap Kosrae and Yap Poor operation and inadequate maintenance Trained management team with adequate of the facilities resulting in delivery of unsafe capacity water Regular monitoring and maintenance of the Small-scale flooding due to system breaches system Impacts to worker health and safety Workers trained in appropriate safe working Occasional, minor localized spills of chemicals practices, safety equipment made available as used for chlorination necessary Chemicals properly stored and handled; spills cleaned up promptly Chuuk Chuuk Poor management Trained management team with adequate Health and safety risks capacity Environmental effects (noise, pollution) Regular monitoring and maintenance of the

60 Appendix 14

Project Phase Potential Effect Mitigation Measures system Accidental spills Workers trained in appropriate safe working practices, safety equipment made available as necessary Adverse environmental effects minimized through effective management and equipment maintenance SPCC plan operationalized Chemicals properly stored and handled Spills of fuel, chemicals, solvents cleaned up promptly Pohnpei Pohnpei Effluent water damaging mangroves System properly managed and maintained to Inappropriate disposal of hazardous materials ensure high-quality effluent into sewer lines Education program implemented regarding Hazards to workers importance of proper disposal practices Inadequate monitoring Workers trained in appropriate safe working practices, safety equipment made available as necessary

E. Environmental Monitoring and Public Participation 5. Preliminary EMPs have been prepared for all four subprojects of the Omnibus Infrastructure Developemnt Project (OIDP) to ensure that the mitigation measures and monitoring requirements approved during the environmental compliance review will be carried out in subsequent stages of the Project. IEEs and SIEEs cover all required details including institutional responsibilities, reporting on EMP implementation monitoring and review, estimated costs, and environmental responsibility procurement plan provisions. The EMPs set out conditions and targets to be met during project implementation. Revised EMPs will be prepared during detailed design. In addition, state government environmental policies, legislation, and regulations provide for continued review during detailed design and will be followed by the respective state governments. 6. Public participation was sought in the course of the project preparatory technical assistance (PPTA). There were numerous meetings with key stakeholders in government, utilities corporations, and the respective communities. A number of surveys were conducted to assess consumers’ attitudes and willingness and ability to pay for the proposed services. Provisions have been made for continuing public participation throughout project implementation. F. Conclusions 7. The Project is expected to bring about significant environmental and public health improvements. There will be no significant adverse effects. The Category B environmental classification is confirmed, which requires no environmental impact assessment (EIA) under ADB's environment policy, relevant operational procedures (OM/F1), and environmental assessment guidelines (2003). The respective state agencies have indicated that the IEE satisfies their preliminary environmental assessment requirements and that full EIAs are not expected to be necessary under local environmental laws and regulations, which will be followed during detailed design.